Jan 27, 2009
Q&A
Should I put some portion of my portfolio in long-term US Treasury bonds as a hedge against deflation?

EFF/KRF: Perhaps, but you would have to put a high probability on deflation. Severe downturns in business activity do not always result in deflation. For example, during the depression of the 1930s, some countries experienced deflation and some experienced hyperinflation. There is lots of talk currently about deflation, but the huge commitments the Fed has made recently seem to be pushing toward higher inflation.

Keep in mind that short term bonds are better hedges against unexpected inflation than long-term bonds. When I roll over short-term bonds, I take advantage of market updates of inflation forecasts. When I hold long-term bonds, the inflation forecasts built into their prices are likely to become outdated as time passes. Suppose, for example, we have modest unexpected deflation for the next few months followed by high unexpected inflation. A long term bond strategy would work well during the brief period of deflation, but this strategy would suffer a lot when the inflation rate rises unexpectedly.

 
ABOUT FAMA AND FRENCH
Eugene F. Fama
The Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Kenneth R. French
The Roth Family Distinguished Professor of Finance at the Tuck School of Business at Dartmouth College
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Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.