When you buy a bond, you receive interest at a stated rate. But that doesn’t mean the money you receive will be worth anything. Today, some companies are issuing bonds at such low interest rates that investors are receiving less than the rate of inflation. This means that in real terms, meaning inflation-adjusted, investors are actually losing money, and it’s all because of the Fed.
The ICE BofA U.S. corporate index for bonds maturing within five to seven years reflects negative real yields for the first time since 2013. Apple just issued bonds that mature in 10 years and pay a paltry 1.16% interest, when the long-term inflation expectation is 1.72%. This means investors lose 0.52% of purchasing power every year.
The central bank is driving this trend by doing two things, holding interest rates near record lows, and telling investors they plan to keep them there for a long time.
Last week, Fed Chair Jay Powell told investors that the central bank has changed its stance. The Fed will now boost employment by holding interest rates low even as inflation creeps higher.
The Fed is making the situation worse by purchasing $140 billion in bonds every month. This leaves fewer bonds for other investors to buy, so they bid up the price, which drives down the yield.
Robert Tipp, chief investment strategist at PGIM Fixed Income in Newark, said:
“On the real economy side, the opportunities for investing in high returns are not really there. As a result, that liquid cash goes into the market where at least you can adjust if the world changes.”
Unfortunately, if yields unexpectedly move higher, all those investors buying bonds that pay 1% to 2% interest, will lose value if they try to sell.