I keep reviewing my bond fund duration and questioning my choice. Maybe this analyses of the past rate rise history will help others. It will definitely help me to get the story straight.
The Fed forced short rates higher starting in early 2004 and lasting for about 2 years. You can see this here and the current situation in late Dec 2013:
You can see that the 3 month Treasury (green
) was made to rise in a linear fashion and that at first the 5 year (blue
) and 2 year Treasuries (red
) rose together. But then the 2 year Treasury rose faster and the spread narrowed. Eventually the condition of yield curve flattening occurred. Historically this is not good for equities but that's another story.
So what happened to bond fund returns? The compound annual real
returns (real CAGRs) during this 4 year period from Jan 2003 to Feb 2007 are shown here for some funds I track:
intermediate VBTLX 0.7% Vanguard Total Bond Market
intermediate PTTRX 1.7% Pimco Total Return
intermediate DODIX 1.5% Dodge & Cox Income
short term VFSUX 0.7% Vanguard Short Term Investment Grade
cash VMMXX -0.3% Vanguard Prime Money Market
We see that intermediate bonds did better then short term bonds and much better then cash in the last rate rise. As it turns out the spread in Jan 2003 between the 5yr and 2yr Treasury was about the same as it is right now
. This was not the case at the beginning of 2013. I think this is an important point.
My guesses after reading the tea leaves
So my guess is that going forward the Fed will raise rates maybe in 2015. Eventually the economy will cause the Fed and the markets to make the short rates move up faster as animal spirits take over.
The good news now is that the spreads are wide enough that it pays to be in intermediate bonds. Since we are starting at lower rates then in 2003, the real CAGR's for the next 3 or 4 years might be close to zero. Since intermediate bonds historically have yielded about 2.3% real returns, this will be disappointing. However, should real returns be low the intermediates will still keep one's purchasing power intact and fulfill the safety mission in one's portfolio.
My own bond portfolio is mostly intermediate bond funds with some short term bonds for spending in the next year.
Go ahead, gentle critiques welcomed.