Rivelle on the Risks of Government Securities

Michael Herbst: You've also written in recent commentary that some of the government's efforts to revitalize pockets of the market that were particularly hard hit in '08 could actually pose dangers or risks to governmental securities, including U.S. Treasuries or even TIPS at this point. Could you comment on some of the risks that investors should be considering regarding government securities right now?

Tad Rivelle: Well the dilemma that we face as a society and our policymakers face is how do you respond to an economic crisis of the scale that we have experienced, an economic crisis that we haven't seen since the Great Depression, and respond to it so robustly that you reduce, collectively, the chance of a depression, which is effectively what we were beginning to see shades of last fall and in the first couple of months of this year? How do you reduce the risk of depression to be so small, so de minimis, that you do not, in the process, almost by the very nature of your response overdo it and end up with not only reflation, which we do think we are going to experience, but some measure of inflation?

<TRANSCRIPT>Whether we see inflation, or reflation, or some combination of the two, our conclusion would be that Treasury rates are far too low relative to where they should be in some type of an equilibrium.

Two-year Treasuries are still less than 1% from a yield standpoint, and even 10-year Treasuries, though they have sold off and therefore have risen in yield substantially in recent weeks, are still only about 3.5% when you factor in the possibility or the potentiality of inflation going back to even long-term norms in this country.

Assuming that we don't even get a full measure of inflation from this, the 10-year Treasury is still too low from a yield standpoint, and therefore too high from a pricing standpoint.

Herbst: And if those prices are too high and they might fall, that could pose a serious risk to investors heavily invested in Treasuries, correct?

Rivelle: Yes. I think that one of the dangers that fixed-income investors--or one of the conceptual traps that fixed-income investors sometimes fall into is this conflation of the idea that Treasuries: high-quality, low-risk. That is not necessarily the case. The risk of a Treasury when it is yielding next to nothing is actually significantly elevated in a sense that it has got nowhere to go but lower from a pricing standpoint.

Conversely, even though the experience of 2008 might suggest otherwise, is the conflation of the idea that corporate bonds, high-yield, lower-rated securities are somehow inherently riskier is not necessarily the case when they are priced at levels that have already discounted such an abundance of bad news, if I could put it that way, that in a sense they almost have nowhere to go but up from a pricing standpoint.