U.S. Treasury bonds continue to get pounded this quarter following their steepest losses since the Federal Reserve started raising interest rates in 2004. And, despite Treasury purchases by the Fed to contain a rising yield curve, intermediate and long-term bond prices continue to decline sharply.

In 2009, long-term government bond prices have plunged 10.3%, according to the Barclays Long-Term Total Return Price Index.

Meanwhile, investment grade and speculative bond issues are posting strong rallies over the last eight weeks as yields decline. Yet this rally is occurring at the expense of T-bonds as investors lunge after risk again.



As long-term rates continue to rise, mortgage rates have also begun to edge higher – a segment of the credit market the Fed is trying to aggressively influence through mortgage agency debt purchases since last November.

The S&P 500 Index or the U.S. broader market has now surged more than 30% since its last intermittent low on March 9. Soaring equity values are pressuring bonds as investors dump fixed income securities in favor of stocks amid the perception that global economic growth will recover over the next six months following the worst bear market for stocks in 2008 since 1937.

Rising interest rates now pose another challenge for the Fed. As stocks rally investors are forcing longer term rates higher, jeopardizing any sustainable recovery as consumer rates and mortgage rates climb. Will the Fed continue to aggressively purchase Treasury bonds even as the yield-curve rapidly steepens?

Though I’m certainly bearish longer term on Treasury bonds, especially longer dated securities in the wake of seemingly never-ending Treasury issuance and a massive inflation problem down the road, bonds are beginning to look attractive again as stocks hit positive territory in 2009 for the first time since 2007.

If equities are now overbought then government bonds might be undervalued over the near term as investor euphoria returns right at the wrong time.

Despite massive concerted global government stimulus spending, the case for sustainable long-term domestic consumption is poor in the face of soaring job losses, idle factory capacity output and, for the first time since 1955, a negative inflation rate. Companies do not have pricing power to sustain a meaningful earnings recovery – especially at a time when consumers in the United States are becoming frugal again and building their savings rates.

Maybe it’s time to buy smashed-out bonds again ahead of another correction in stock values this summer. Once again it would appear that investors are critically underestimating the collateral damage inflicted by this historical credit squeeze. Time will tell if this is indeed a new bull market or just another false rally in the context of a secular bear market.