US bond at 5% promises income, but inflation eats it alive

US bonds at 5%: yield or trap

The yield on US Treasuries has settled at 5%, a level that has peine the question of whether this is the last great fixed-income opportunity or a prelude to disaster. The question is not trivial: with the money-printing machine running, inflation threatens to eat up any real gain. Some point out that for a retiree who simply wants to live off coupons, the erosion of the principal matters little.

The inflation that devours the 5%

The debased-money argument hangs over the US bond. If the Federal Reserve keeps printing, the nominal 5% yield may be an optical illusion. And for the European investor, there is an extra risk: the exchange rate. Anyone buying dollar-denominated debt accepts that, if the currency turns against them, the coupon evaporates. So much so that some prefer money market funds or, outright, a strong external currency in case Europe also collapses. The temptation of Whirlpool's 8%, freshly bailed out, shows just how far the risk goes for anyone chasing guaranteed returns.

The PER that doesn't measure up

The other side of the debate is the effect on equities. With bonds yielding 5% over 5-10 years, every company should trade at a price/earnings ratio below 20. The reality is that few do, and those that manage it do so through debt or stagnation. With a risk-free asset yielding that much, institutional money will migrate to bonds and stocks will suffer.

The underlying question remains hanging: if the US stock market ends up rallying relentlessly while the currency depreciates, as has already been seen elsewhere, the 5% will have been a mirage. For now, the only consensus is that nothing comes free. And with the printing machine running, that may be today's greatest certainty and tomorrow's greatest disappointment.