Bonds and rising rates

[bobbee25]

If you purchase intermediate term bonds and the interest rate goes up 1%, it appears that you would loose around 4%. If the bonds are paying 5 - 8% now and you loose 4%, seems like you would still be ahead of those 2% CDs.

 

[Stevewc]

I hope you are right but this article caught my eye this morning:

Top Stocks Blog - MSN Money

I posted it on another bond fund thread but decided to add it here also. Please read and give your thoughts as to how much this artificial manipulation on interest rates by the Fed might affect bonds and bond funds. I think the Fed plans to stop in Oct 2009.
Steve

 

[audreyh1]

it's not as simple as some articles make it out to be. Different duration interest rates can go up as different percentages. For example, in the 2004 interest rate hikes, the short duration funds got hurt the most. Short term interest rates went up, while longer term interest rates hardly moved at all. Intermediate and long duration bond funds saw little pain. This suprised a lot of people.

So the question really is - how will the Fed raising short term rates affect the yield curve? Will it stay they same slope, but just move to higher rates across all durations - in which case longer duration funds will be hurt more than short.

Or will the curve "flatten" - the short end moving up while the intermediate/long doesn't move much. In this case most of the pain is felt at the short end. Curves flatten when investors think that raising short-term interest rates will reduce future inflation and/or hurt economic recovery.

I suspect with super low short term rates - 2.5% or lower - which are extremely unusual historically, but have occurred twice in the 2000s - there will be some flattening.

Audrey

 

[audreyh1]

I hope you are right but this article caught my eye this morning:

Top Stocks Blog - MSN Money

I posted it on another bond fund thread but decided to add it here also. Please read and give your thoughts as to how much this artificial manipulation on interest rates by the Fed might affect bonds and bond funds. I think the Fed plans to stop in Oct 2009.
Steve

On when the Fed quits buying treasuries - which has perhaps helped the 10-year stay so low, and that has helped keep mortgage interest rates low to facilitate housing recovery. I suppose we could see some rises in the 10-year. It has been at 4% a lot over the past two years so I expect it to return there quickly. Could it drift back up to 5%? That really depends on the economic outlook I would think.

Audrey

 

[Lsbcal]

If you purchase intermediate term bonds and the interest rate goes up 1%, it appears that you would loose around 4%. If the bonds are paying 5 - 8% now and you loose 4%, seems like you would still be ahead of those 2% CDs.

Here is one example:
VFITX, Vanguard Intermediate Treasurys
duration = 5yrs
30day SEC yield = 2.4%
So if 5yr Treasurys move up 1% this year, maybe you get 2.4 - 5*1.0 = -2.6%
However, rates could move up a lot slower or not move up at all or go down.

So if one is going into VFITX it should be with the intention of staying fairly long term i.e. for the fund's duration of 5yrs. Then if rates move up you will be getting higher yields as a compensation for taking the rate rise bath. In an interest rate cycle (rates go up, rates go down) this can even out.

Another strategy would be to stay short term and as rates move up go out longer term. Say when 5yr Treasurys are at 4% put in 25% of your funds, then at 4.25% put in another 25%, etc. Just a thought.