Flight to Quality Losing Its Strength

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The move from equities to fixed income has been described as a flight to quality.  No one wants to get stuck holding an investment that can lose value, but at what point will investors want to actually make, not protect, wealth?

US Treasuries

New cash from Wall Street is heading to US Treasury bonds.  At present, the 10-year Treasury bond has surged in value, moving so high that investors must now lock in their capital for ten years to make a paltry 3.2% annual return.  The message that Wall Street is sending is profound: we’re scared so much that we’re willing to accept 3.2% just to keep safe.

A Paradigm

The markets are experiencing a rare happening when rates get crushed even as more and more debt is sold each and every week.  With record federal budgets extending well into the next decade and more, investors will have to swallow auction after auction after auction.

This may be possible right now, when most are complacent and happy with 3.2% returns, but at what point will investors want more?  When will they get greedy?  When will three, four, even five percent fail to be enough? Rates should be rising, not falling.

A Flight to Quantity

The next leg of the race is invariably a flight to quantity, when investors begin to demand more from their investments.  This should happen very quickly after the Federal Reserve begins tightening its monetary policy and raising the rate at which it lends to banks and other institutions.  At that time, the Federal Reserve will have allowed all the credit into the system that it so desires, and the markets should again be able to function as markets.  If the Federal Reserve fails to raise rates, we could see higher rates in Treasuries regardless, since investors will then want protection from inflation.

Debt Will Become Too Much

Everyone knows that the debt loads in the United States are quickly becoming unsustainable, and that at some point, the US may soon face a downgrade.  Moody’s and Standard and Poor’s have both mentioned that they will cut the United States’ credit rating should its finances continue to run out of control.  With that kind of risk, and such unreasonable returns, is it any question whether you should be a part of the next flight to quantity?

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