Defensive Investors Face a Huge Risk and It Has Everything to Do With the Fed

The defensive investor has emerged in May and June, even as U.S. stocks have risen of late. Now, those investors face a big problem. 

Usually, when investors think the economy is losing steam and risky assets like stocks are bound to fall, they'll move into treasuries, which are 'risk free.'

As President Trump's threats to enact additional tariffs on China and Mexico have pressured already falling economic growth forecasts, the U.S. ten year treasury yield has fallen to 2.03% (Bond yields move inversely to prices). Now, that yield is very close to expectations for the federal funds rate, as most investors expect the Federal Reserve to reduce interest rates, suggesting minimal upside to treasury prices from here. 

"There's definitely some interest rate risk," Tracie McMilion, head of global asset allocation strategy at Wells Fargo Investment Institute told TheStreet. "In fact, our ten year target is anywhere from 2% to 2.5%, so we are at the very bottom of that target range, so we would yes, there's some interest rate risk there.

Inflation has struggled to push above 2%, but yields can only offer a real return if they're above inflation. "At 2%, you're barely keeping up with inflation and that's not necessarily a very attractive return for investors," McMillion said. 

Meanwhile, the average dividend yield on the S&P 500 is less than 2%, as the index has surged more than 16% year-to-date. 

Investors sometimes go to cash during this type of market dynamic. News on the G-20 meeting in Osaka, Japan this weekend is sure to give the market clarity.

 Related. The Fed Finally Starts Making Sense, and Here is How to Play It