Bonds Are Not Forever: The Crisis Facing Fixed Income Investors

CHAPTER 6

POLITICS

Government-Controlled Investing

If you’re a bond investor, you have to consider politics and the actions of the federal government. This is not only because they’re the biggest issuer of bonds. It is also because they have a huge impact on market conditions. The federal government sets market interest rates both for short maturities (through the federal funds rate) and in recent years for long maturities (through bond buying programs designed to depress yields, dubbed quantitative easing). Today, the biggest issuer is also the biggest buyer. Bond yields are heavily influenced by the yield on debt issued by the U.S. federal government because the United States is still the most creditworthy issuer despite a downgrade of one notch from the highest triple-A rating by the rating agency Standard & Poor’s in August 2011. However, as all rates are tethered to the U.S. government’s, successful bond investing requires considering the likely course of government fiscal policy.

Discussing government finances, the deficit, tax, and spending policies can quickly become very political. It’s relatively easy to agree on the size of the fiscal challenges facing America. Moving on to how to confront them soon leads to disagreement. This book isn’t going to take a stand on the right and wrong policies to be pursued. Our focus is on investing and assessing in a dispassionate way the range of plausible outcomes. It takes no view on the relative merits of big government versus small ...