Investors are used to the stock market playing havoc with their quarterly account statements. What many people may be totally unprepared for, however, is having to blame their Treasury bond holdings for big losses this time around.
The quiet crash in long Treasuries
If you're like most investors, you probably haven't been paying very close attention to the bond market lately. After all, stocks have put in a stellar performance since the beginning of September, and despite some shakiness in the last week or so, they've largely managed to preserve their gains.
Adding to the distractions are big fluctuations in commodities. Precious metals hit new highs last week before dramatically falling in the wake of the midterm elections and the finalization of the latest round of quantitative easing from the Federal Reserve. Similarly, after having hit levels against some currencies that hadn't been seen in decades, the U.S. dollar rebounded sharply in the past 10 days, as European tensions again return to the forefront, this time with Ireland in the hot seat.
But underneath all the noise, there's turmoil in the Treasury markets. Just take a look at what's happened to rates in the past six weeks:
* Yields on the 30-year bond have risen from below 3.7% at the end of September to 4.37% yesterday.
* Similarly, after going below 2.4% in October, 10-year bond rates are threatening the key 3% level, currently yielding 2.91%.
If such small rises don't seem like too big a deal, consider the impact they've had on Treasury exchange-traded funds. With a rise of far less than a full percentage point in yields, the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT - News) has dropped more than 10% since the quarter began, while Vanguard Extended Duration Treasury ETF (EDV) has fallen more than 18%. Just about the only investors who are happy with the higher rates are shareholders of the inverse ProShares UltraShort 20+ Year Treasury (NYSE: TBT - News), which have given investors a 22% return in a month and a half.
No panic elsewhere
One reason why no one's talking about a bond crash is that most of the market hasn't seen it. Municipal bond prices have fallen sharply in just the past week, but with just a 5% drop since the end of September for the iShares S&P National AMT-Free Muni ETF (NYSE: MUB - News), the declines aren't anywhere near what Treasuries have seen.
Moreover, prices elsewhere in the bond market have hardly budged. In particular, the corporate bond market has stayed quite healthy, with the iShares iBoxx Investment Grade Corporate ETF (NYSE: LQD - News) down just 3% since September. And among the junk bonds that most people would think of as the riskiest, the SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK - News) has actually risen in price since the quarter began.
So far, most Treasury traders aren't panicking. Most are simply saying that the move is compensating for the overblown expectations that investors put on the potential impact of QE2 before the Fed announced its actual plan of attack. Mortgage rates remain at record lows, and the market shows no signs of coming to a halt anytime soon. Just yesterday, Procter & Gamble (NYSE: PG - News) joined the growing list of major companies raising cash, while Prudential Financial (NYSE: PRU - News) sold bonds in part to help finance its purchase of a unit from AIG.
But in the long run, the damage from rising rates is extremely unlikely to be limited to the Treasury market. While a healthier economy will support the corporate market generally and especially high-yield issuers, it's important to remember that one of the Fed's most important objectives is to prevent deflation -- even if it causes an inflationary spike later on.
That's likely part of what long Treasuries are catching a whiff of right now, and it's exactly the sort of catalyst that could create unanticipated consequences, either now or down the road.
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Fool contributor Dan Caplinger thinks things are gonna get nasty soon. He doesn't own shares of the stocks or funds mentioned in this article. The Fool owns shares of and has written covered calls on Procter & Gamble, which is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy loves bulls and bears alike.