Are Bonds Headed for a Correction?

This week's aggressive moves by the Federal Reserve to shore up the U.S. financial system have temporarily taken the heat off share prices. Unfortunately, they may have also set the stage for at least a short-term correction in Treasury bonds.

In recent months, investors seeking shelter from ongoing turbulence in credit markets have piled into government-issued securities. Along with growing worries over the health of the economy, that has helped drive down yields on 10-year Treasury bonds to around 3.5%.

Yet in their mad dash for safety, investors have been ignoring a number of warning signs, including the threat of rising inflation. Strength in gold, oil and other commodity prices, persistent weakness in the dollar, and the belief that central bankers have relegated inflation-fighting to the back burner have only heightened concerns that prices for goods and services are headed higher.

The greenback's declining fortunes also seem to be weighing on foreign demand for U.S. bonds. That is an especially worrying development given our nation's large current account deficit and our long dependence on the kindness of investors based elsewhere.

In fact, Britain's Daily Telegraph recently suggested that "foreign bond holders have begun to exercise a collective vote of no confidence in the devaluation policies of the U.S. government," noting that "Asian, Mid East and European investors stood aside at last week's auction of 10-year U.S. Treasury notes."

The prospect of rising federal deficits, financed mainly by borrowing, is also a negative for bond prices going forward.

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At the time of publication, Panzner had no positions in the stocks mentioned, although positions may change at any time.

Michael Panzner is a 25-year veteran of the global stock, bond and currency markets who has worked in New York and London for HSBC, Soros Funds, ABN Amro, Dresdner Bank and J.P. Morgan Chase. He is the author of Financial Armageddon: Protecting Your Future from Four Impending Catastrophes and The New Laws of the Stock Market Jungle: An Insider's Guide to Successful Investing in a Changing World, and is the publisher of the Financial Armageddon blog. Panzner is also a New York Institute of Finance faculty member. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Panzner appreciates your feedback; click here to send him an email.

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