After a lackluster 2013, the fixed income world is finally gaining some traction this year. In particular, investors are adding long-term Treasuries to their portfolio as surprisingly weak jobs growth and low inflation for December raised concerns about sustained economic improvement and continuation of Fed taper plans.
The U.S. economy added just 74,000 jobs in December, much below analysts’ expectation of 200,000 (as polled by Reuters). This represents the slowest job growth rate in three years. However, this weakness could be largely due to severe cold weather, which is a temporary factor.
Though annual inflation rate was at 1.5% in December — the largest increase in six months — it is still far cry from the Fed’s target of 2%. The combination of feeble job numbers and persistently low inflation, boosted the appeal for the long duration bonds. This is because low inflation will continue to keep interest rates at lower levels for longer than expected, driving the yields down and bond prices up.
Further, if inflation continues to fall or job numbers continue to disappoint, the Fed might take a cautious stance on its plan to curb QE3 by extending the timescale of its tapering process or holding off reductions for longer than initially expected.
After months of speculation, the Fed finally decided to cut its bond purchases by $10 billion starting this month. It also reiterated that the scaling back of asset purchases wasn’t on a preset course, and that future decisions on asset purchases would be made based on upcoming data releases (read: Fed Tapers Bond Purchases: 3 ETFs in Focus on the News).
All these factors are encouraging investors to enter into the bond market. As such, long-term Treasury funds like iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT) and Vanguard Extended Duration Treasury ETF (NYSEARCA:EDV) have witnessed strong momentum to start the year.