The Bond Market's Shaky Foundation

I don't know if you've ever prowled around an old deserted house. I did when I was a kid. The floors would shake with each step. Patches of dry rot threatened to give way and send you plunging into the basement. If you put your weight against a beam, the whole house would sway. Exciting -- and dangerous.

Unfortunately, that's also a pretty good description of today's bond market. The unstable foundation is built on overseas cash flows and currency manipulation by foreign central banks. Dry rot threatens the whole system of credit ratings. And some of the banks propping up the market for credit derivatives shake at the slightest touch.

The professionals in this market -- the traders, the underwriters and the more sophisticated investment banks -- know exactly how shaky the whole edifice has become. They're determined not to be the last out the door.

The result? It doesn't take much to turn a market decline into a rout. That's exactly what happened in the four weeks that ended June 12. In that period, yields on the 10-year U.S. Treasury bond soared from 4.7% to 5.25%. Prices on this "safe" bond plunged 10.5%.

And while bond prices have stabilized for the moment, nothing fundamental has changed about the nature of this market. We could get another replay of this panicky drop at any time over the rest of the year.

A Novel Idea: Cash

What should you do if you've got money in the bond market? Ever hear of something called "cash"? With the 10-year Treasury bond yielding a tad less than 5.25% and banks paying a top rate of 5.25% to 5.45% on a 12-month federally insured certificate of deposit, I frankly don't see any reason to take on the risk in bonds right now. Let bond prices recover a bit from the recent panic, and then move.

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