There is still no value in bonds today.

Many readers just had a knee-jerk reaction and they’ve determined that I fall into one of two categories:

But let’s dig a bit deeper into the claim that bonds lack “value,”  even with this quarter’s 85 basis point back-up in 10 year treasury note yields.

One way to view value within non-credit fixed income assets is to deconstruct interest rates into their nominal and real components, while also recognizing that investors typically demand a term premium to hold interest rate sensitive bonds. Recent research summarized in this article advances the measurement of both real rate and the term premium. Unfortunately, I’m of the opinion that neither real rates or term premium are paying bond investors enough to make it worth the risk associated with locking away their money and accepting potentially high interest rate volatility.

Estimating Expected Inflation and Real Interest Rates

At their core, interest rates compensate investors for delaying the gratification of spending money today instead of the future. The biggest component of making that decision is usually how the cost of purchases you hope to make today compares to their expected cost in the future. In other words, what is expected inflation.

Since the advent of TIPS (Treasury Inflation-Protected Securities) which, as their name implies, are protected from inflation, we can back into expected inflation (the break-even rate or difference between the nominal Note and TIP yields), at least in a risk free world.  When graphed over longer periods of time, you can see the drop in yield of both the 10 year Treasury note and in the “real” interest rate — what you really earn after taking into account inflation as measured by the 10 year TIP yield. Over the last few years, that real interest rate amount has been paltry and has even gone negative.