Buy or avoid ROI-US bonds with a yield over 5%? Mike Dolan

The U.S. bond yields have crossed 5% eight times or more in the last three years, but never stayed there. The question of whether 'dragons' or 'buyers" are above this level is critical for an investor base who has become sour about?super-long term government debt.

The appetite for long-term bonds is still important, as 17% of Treasury debt maturing in the next 10 years will be held by the U.S. Treasury. This appetite is being affected by a 'cocktail' of factors, including inflation, corporate debt, dollar value and foreign ownership.

A 5% coupon per year from the U.S. Treasury is a nice source of income, especially in an uncertain economy. This is well above the average 4.2% of the last 30 years. If you don't touch your money until the end, the compound interest will more than quadruple it over the next three decades.

The real potential return on investment is another matter.

If the Federal Reserve is successful in keeping inflation at its 2% goal, a long-term 5% bond will net you a real gain of 150% in inflation adjusted terms. Even if inflation exceeds the average 2.3% rate implied by the 30-year inflation linked debt market, a 5% coupon would only double your money.

Add to that, the fact that the administration is encouraging the possibility of the dollar's near-50 percent rise in the last 15 years being substantially undone and foreign investors who hold U.S. Bonds taking a hit.

It is more important than it was before. Over the last decade, foreign investors' share in U.S. Treasury Bonds with maturities greater than 10 years has increased by more than two-fold to 14%.

The obvious alternative for everyone else over the last half-century has been clear. With dividends reinvested in the S&P500, your money would have grown 15-fold during the last three decades, and roughly the same amount over the next 30 years.

The inflation also takes a toll on that, but relative returns remain high.

The artificial intelligence boom continues, despite persistent worries about the compressed equity risk premiums with stocks at all-time highs. It continues to confuse both stock market bears and economic bears. Goldman Sachs expects to spend $7.6 trillion on AI infrastructure by 2031.

The "hyperscalers" who are leading the AI push finance their spending through long-term debt. This creates a new competition among corporate borrowers for Treasuries in the search for debt financing.

Morgan Stanley anticipates record corporate bonds this year. Tech borrowing will be a large part of it. This year, the supply of investment-grade bonds is expected to increase by more than 20% annually with maturities longer than average.

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This is just one of many headwinds that are hitting sovereign debt and in particular long-duration maturity.

First, the debt is increasing everywhere. The repeated shocks have prevented any real retrenchment. Populist political movements in Japan, Europe, and the U.S. promise ever more tax cuts or spending, but none are willing to reign in the rising deficits.

The midterm elections in the U.S. this year are likely to be a gridlock. Barclays strategists pointed out this week that "historical experience with divided government tilts financial risks towards looser outcomes."

Barclays warned that lower tariff revenues, due to legal resistance and other factors, could make the cumulative 10-year deficit in the United States $700 billion higher than the already gloomy estimates of the Congressional Budget Office. This could then lead to higher schedules for debt sales and eventually higher "term premiums" in borrowing rates.

In many cases, the demographic shifts in ageing populations that used to see pension funds accumulating ultra-long government bonds to match their liabilities are now reversed. The 'pension funds' are being drawn and the?funds have moved down in maturity.

Inflation is high and expectations of inflation are also high. This is exacerbated by the fact that oil prices have risen again this year and trade tariffs are rising. Geopolitics has been volatile and threatens supply chains and energy market for many years.

This constrains central bankers from cutting interest rates further, but also keeps the risk of the next move high. If rates don't rise soon, the risk of inflation expectations that are already high in the short term extending further into future decades is growing.

There is also the Fed. Kevin Warsh, the new Fed chairman, is expected to take office later this month. He has stated that he wants to reduce the Fed's debt and the maturity of the $6.7 trillion. As of now, 36%?of the debt held by the Fed has a maturity period of 10 years or longer.

The 5% Treasury bond yield is a welcome relief to?banks that hold bonds due to regulatory requirements or for foreign central banks who need dollar reserves.

What about as an investment? Dragons are real.

The opinions expressed are those of Mike Dolan a columnist at. This column is great! Open Interest (ROI) is your new essential source of global financial commentary. Follow ROI on LinkedIn and X. Listen to the Morning Bid podcast daily on Apple, Spotify or the app. Subscribe to the Morning Bid podcast and hear journalists discussing the latest news in finance and markets seven days a weeks.

(source: Reuters)