This week when Federal Reserve Board Chairman Ben Bernanke said the economy isn't likely to slide back into recession, he gave bond fund investors another clue that the end of the best days for bond funds may be nearing an end.
A Tale of Two Economies
In Bernanke's Tuesday, July 17, testimony to Congress, painted a negative picture of the near-term economic outlook. In his semi-annual report on monetary policy issues, Bernanke said that the reduction in the unemployment rate will likely be "frustratingly slow." This is his way of telling markets that he may buy more Treasury bonds to keep a lid on interest rates, thereby stimulating the economy (or so the theory goes). This can be positive for bond fund investors because low or declining rates (or the expectation of them) can mean stable or rising bond prices.
However, in Bernanke's Wednesday, July 18, testimony, he told Congress that he doesn't expect a double-dip recession. Wait a minute. Isn't this the opposite of his testimony the day prior? Of course it is! Bernanke is trying his best to ride the fence, so to speak. He wants to calm markets by assuring investors he is ready to take action if unemployment weakens but he is also telling investors not to worry too much about a new recession.
Reading Between the Lines: Bad News for Bond Fund Investors
In summary, Bernanke wants everyone to be in a good mood. Hey, things aren't too bad so why don't you go and buy some stocks, bonds and mutual funds? And while you're at it, go buy some things at Wal-mart and hire some new employees if you're a business owner!
My interpretation of Bernanke's testimony is that he is playing the safe area of staying away from election year politics and won't give away any obvious clues about any near-term (6-month) Federal Reserve actions. However, he's not foolish enough to say he doesn't expect a double-dip recession if he's not fairly certain (relatively positive) about the direction of the US economy for the next 6 to 18 months.
What this means is that the Fed will try to stay on the sidelines and let the economy work out its challenges until he thinks its time to start raising interest rates again, which he has stated he would do in the year 2014 (18 months from now). Since interest rates move in the opposite direction as bond prices, bond funds are not likely to do well over the next several months and could even decline in value.
What Can Bond Fund Investors Do Now?
Stay tuned for some alternative ideas for your fixed income (bond) portfolio in the coming days. In the mean time, you can brush up on your bond fund basics and refresh your memory on the difference between bonds and bond mutual funds.