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The Beginning of the End?

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Investors are used to the stock market playing havoc with their quarterly account statements. What many people may be totally unprepared for, however, is having to blame their Treasury bond holdings for big losses this time around.

The quiet crash in long Treasuries
If you're like most investors, you probably haven't been paying very close attention to the bond market lately. After all, stocks have put in a stellar performance since the beginning of September, and despite some shakiness in the last week or so, they've largely managed to preserve their gains.

Adding to the distractions are big fluctuations in commodities. Precious metals hit new highs last week before dramatically falling in the wake of the midterm elections and the finalization of the latest round of quantitative easing from the Federal Reserve. Similarly, after having hit levels against some currencies that hadn't been seen in decades, the U.S. dollar rebounded sharply in the past 10 days, as European tensions again return to the forefront, this time with Ireland in the hot seat.

But underneath all the noise, there's turmoil in the Treasury markets. Just take a look at what's happened to rates in the past six weeks:

  • Yields on the 30-year bond have risen from below 3.7% at the end of September to 4.37% yesterday.
  • Similarly, after going below 2.4% in October, 10-year bond rates are threatening the key 3% level, currently yielding 2.91%.

If such small rises don't seem like too big a deal, consider the impact they've had on Treasury exchange-traded funds. With a rise of far less than a full percentage point in yields, the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT  ) has dropped more than 10% since the quarter began, while Vanguard Extended Duration Treasury ETF (EDV) has fallen more than 18%. Just about the only investors who are happy with the higher rates are shareholders of the inverse ProShares UltraShort 20+ Year Treasury (NYSE: TBT  ) , which have given investors a 22% return in a month and a half.

No panic elsewhere
One reason why no one's talking about a bond crash is that most of the market hasn't seen it. Municipal bond prices have fallen sharply in just the past week, but with just a 5% drop since the end of September for the iShares S&P National AMT-Free Muni ETF (NYSE: MUB  ) , the declines aren't anywhere near what Treasuries have seen.

Moreover, prices elsewhere in the bond market have hardly budged. In particular, the corporate bond market has stayed quite healthy, with the iShares iBoxx Investment Grade Corporate ETF (NYSE: LQD  ) down just 3% since September. And among the junk bonds that most people would think of as the riskiest, the SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK  ) has actually risen in price since the quarter began.

What's next
So far, most Treasury traders aren't panicking. Most are simply saying that the move is compensating for the overblown expectations that investors put on the potential impact of QE2 before the Fed announced its actual plan of attack. Mortgage rates remain at record lows, and the market shows no signs of coming to a halt anytime soon. Just yesterday, Procter & Gamble (NYSE: PG  ) joined the growing list of major companies raising cash, while Prudential Financial (NYSE: PRU  ) sold bonds in part to help finance its purchase of a unit from AIG.

But in the long run, the damage from rising rates is extremely unlikely to be limited to the Treasury market. While a healthier economy will support the corporate market generally and especially high-yield issuers, it's important to remember that one of the Fed's most important objectives is to prevent deflation -- even if it causes an inflationary spike later on.

That's likely part of what long Treasuries are catching a whiff of right now, and it's exactly the sort of catalyst that could create unanticipated consequences, either now or down the road.

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Fool contributor Dan Caplinger thinks things are gonna get nasty soon. He doesn't own shares of the stocks or funds mentioned in this article. The Fool owns shares of and has written covered calls on Procter & Gamble, which is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy loves bulls and bears alike.

Read/Post Comments (7) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 16, 2010, at 1:37 PM, noryakerson wrote:

    I've put all my money into tulip bulbs.

  • Report this Comment On November 16, 2010, at 3:01 PM, Joelshann wrote:

    I agree with the decline, and purchased TBT several weeks ago (which puts me at break even right now) based on charts of moving averages and the turn in yeilds/prices.

  • Report this Comment On November 16, 2010, at 5:44 PM, mountain8 wrote:

    Diversify Noryakerson, Think about pet rocks.

  • Report this Comment On November 16, 2010, at 6:17 PM, Bonefish100 wrote:

    I'm in for the tulip bulbs...

  • Report this Comment On November 17, 2010, at 1:35 AM, ET69 wrote:

    I'm also in for the tulip bulbs too and I will raise ya light bulbs!

  • Report this Comment On November 17, 2010, at 11:56 AM, devans10KK wrote:

    Fools rush in... Tulip bulb's markets already popped, and they do still grow. I pick GOLD.

  • Report this Comment On November 17, 2010, at 12:55 PM, jfrankh57 wrote:

    Think commodities! Buy something that will last for a lifetime. Everybody disses land, but the population increases and land does too, albeit at a much slower rate and with the threat of global warming, we may well be back to basics in the future and if not, the crush of humanity can only increase land's intrinsic value.

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