The week ahead

Tom Hudson: What next in the bond market

 

Special to The Miami Herald

The bond market is bending, taking investors with it. Every day that goes by, bond market investors figure is one day closer to the Federal Reserve scaling back its monthly purchases of IOUs designed to keep interest rates low. But last week’s statement from the Central Bank left it’s strategy intact. Still, the bond market isn’t waiting for the official pronouncement. Instead, a steady climb of interest rates that began in May looks to continue in the new week.

Borrowers have been lulled into complacency thanks to five years of falling interest rates. Driven first by the near-collapse of the financial system, then dysfunctional federal government responses and a stubbornly weak economic recovery, the Federal Reserve has taken unprecedented and untested actions to bring down the cost of cash with the goal of encouraging borrowing. Investors took notice and followed the Fed into the bond market in a big, big way. More than $640 billion dollars have been thrown at bonds in the past three years. Those investors may be wary of the stock market, but they aren’t stupid. For the first time in almost three years, investors have taken money out of bond mutual funds two months in a row. The Investment Company Institute estimates $76 billion has been pulled since the beginning of June. But for every $1 invested in bond funds over the previous three years, only 12 cents have been redeemed.

An orderly exit from the bond market gives the economy time to adjust to the higher cost of borrowing, but investors may not be as patient as the Fed.

Tom Hudson is a financial journalist based in Miami. He is the former co-anchor and managing editor of Nightly Business Report on public television. Follow him on Twitter @HudsonsView.

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