Predicting Interest Rates (and thereby a "bond bubble")

[Midpack]

We've all seen these discussions [-]way too many[/-] several times, but I thought this chart from Vanguard might be illuminating. What it predicts is, we (including the pros) can't predict - way more often than not. Those who have been [-]screaming[/-] [-]begging everyone[/-] suggesting we should all get out of bonds for the past 3+ years are conspicuous on the chart. Not that "they" won't be right eventually of course, they will indeed. But it's nice to have the yields in the meantime without the volatility of riskier asset classes.
As always...YMMV

The thin lines are the market's interest rate predictions--not one guru's vision, the wisdom-of-the-crowds prediction. The thick lines are what actually happened. Notice the utter failure to be even approximately right even as little as one year ahead. People have trouble understanding this chart, and I think the reason is that they can't actually believe what they're seeing. Thin little hairs? Prediction. Thick line? Fact. Any place it looks bushy, the predictions were badly wrong. It looks bushy everywhere.

 

[GrayHare]

It's The Game of Musical Bonds: try to guess when the low-interest music will stop.

 

[audreyh1]

Nice chart!

I don't know where the above predictions came from - there are so many analysts spouting off opinions every day. Some bond professionals follow the futures on Fed Funds Rate which currently predicts no tightening until Q4 2015 - quite a departure from the "imminent tightening" noise we seem to hear every day. Year-End Market-Based Rate Forecasts

Moral of the story? Most talking heads on TV are pushing an agenda and their assertions tend to be unreliable. You really should tune them out.

 

[audreyh1]

It's The Game of Musical Bonds: try to guess when the low-interest music will stop.

Q4, 2015? (when it will just start to stop).

 

[GrayHare]

2016 should be an interesting year: presidential election and Millennials turning age 35 are both bullish for stocks. Interest rates rising (up to 5% on the 10 year) are also bullish.

 

[Animorph]

Looks like lots of people didn't believe what the Fed was saying 2010-2012. How hard was that to predict?

 

[audreyh1]

Looks like lots of people didn't believe what the Fed was saying 2010-2012. How hard was that to predict?

LOL!

 

[pb4uski]

I recall when I was in grad school (mid 1980s) we had a speaker from the Fed and IIRC he said it was virtually impossible to predict interest rates. Looks like it is still true.

 

[akck]

Rates became easier to predict when the Feds started signaling their intentions out longer. They used to signal out about 9 months and kept signaling the same info with each meeting. In June 2012, the Fed extended the period out to between 1 and 2 years, which means little change until sometime in 2014 at the earliest.

If you figure a slow ramp-up in rates, rates will climb over 1-2 years. Long term bond funds will take a hit in value as the rates climb, but it will be manageable. If you figure a rapid rise in rates, say 6 months to a year, long term bond funds will take a serious hit. Short term bond funds won't be hurt as badly with their shorter duration and rolling maturities, allowing them to buy into rising rates.

With the Feds last meeting, they threw out some mixed signals, so it looks like they'll continue to hold down rates until the end of 2013 and not well into 2014. At the earliest, rate may start to head up in the first two quarters of 2014 (maybe end of 2013 in anticipation). By this June, we may be back to that 9 month outlook again, giving further credence to rising rates.

Delays in Fed planning are likely more common as they gage current predictions of economic progress. They aren't likely to accelerate plans as it will hit the economy and long term bond funds the hardest.

 

[audreyh1]

IIf you figure a rapid rise in rates, say 6 months to a year, long term bond funds will take a serious hit. Short term bond funds won't be hurt as badly with their shorter duration and rolling maturities, allowing them to buy into rising rates.

Don't be so sure about that. The last time the Fed raised rates (rather quickly), the short-term bonds got hit hard, the mid-term bonds didn't get hit at all, and the long-term bonds actually went up a wee bit.

Why? Because the Fed Funds Rate controls the shortest term rates, not the long term rates. When they raised rates, the yield curve started to invert in anticipation of future economic slowing due to higher interest rates.

It's likely the Fed will be unwinding its longer maturing bond purchases before any raising of short-term rates, so this may impact the longer term bonds (lowering their value) well before the Fed Funds Rate is increased. We'll just have to see how it all unwinds!

 

[Midpack]

Nice chart!

I don't know where the above predictions came from - there are so many analysts spouting off opinions every day. Some bond professionals follow the futures on Fed Funds Rate which currently predicts no tightening until Q4 2015 - quite a departure from the "imminent tightening" noise we seem to hear every day. Year-End Market-Based Rate Forecasts

Moral of the story? Most talking heads on TV are pushing an agenda and their assertions tend to be unreliable. You really should tune them out.

I didn't take the time to find the source when I composed post #1, but I felt a tinge irresponsible doing it, and you've now (fairly) nudged me over the edge.

FWIW I suspect this is it, see fig3 on pg5 https://institutional.vanguard.com/iam/pdf/VIPS_Deficits.pdf ...

...in the section titled "Bond-market expectations: Often reasonable, but often wrong"

 

[imoldernu]

The Vanguard conclusion relates to the state of the economy in foreign nations.
Since the Fed does not exist in a vacuum, bond rates integrate with the fortunes of other countries. With the possible exception of China, the economies of almost all of the major states have survived over the past three years as a result of pumping up government spending. The low hanging fruit of municipal infrastructure, and stimulus spending is reaching a point of diminishing returns in all of the Euro states, Japan and India, and especially the US, where it is most obvious in the expanding debt.
China may be in a different class, but it too, is still driving much of the economy by growth spending, theoretically more efficient, but bogged down by inefficiency from an inexperienced and corrupt government. Latest estimates of growth are inconclusive.

Bringing it down to the FED... Can the Fed actually control rates apart from the perceived safety of the US debt held by others?

I'm looking to Europe as an indicator for the direction of rates in the balance of 2013.

Good thing I'm not into this stuff with my own money... so far, over the past 15 years, I've been correct in predicting what will happen... Problem is, the actual changes have trailed the predictions by about 2 years.

Well heck, ya gotta have somebody to call a wacko.

So, anyway, watch Europe for liquidity problems.

 

[akck]

Don't be so sure about that. The last time the Fed raised rates (rather quickly), the short-term bonds got hit hard, the mid-term bonds didn't get hit at all, and the long-term bonds actually went up a wee bit.

Why? Because the Fed Funds Rate controls the shortest term rates, not the long term rates. When they raised rates, the yield curve started to invert in anticipation of future economic slowing due to higher interest rates.

It's likely the Fed will be unwinding its longer maturing bond purchases before any raising of short-term rates, so this may impact the longer term bonds (lowering their value) well before the Fed Funds Rate is increased. We'll just have to see how it all unwinds!

As I recall, last time the Feds didn't target long term rates, that is, they were working the short end of the yield curve. This time with the "Twist," the long end was pulled down. Rates that were in the 5% range are now in the 3% range on the long end, at least a 2% drop. Whereas, rates on the short end are down less than 1%. If rates were to climb back to the "norm," long term bond funds could see a 10-20% drop in value, compared to under 5% for a short term fund.

The Feds were divided as to when to unwind. Some wanted to unwind mid-year, while others wanted the end of the year. I think indecision will leave it in place to the end of the year, so we'll see rates going up in 2014. Of course, it all depends on the economy in the next 9 months.

 

[enjoyinglife102]

Maybe someday it will sink in; no one can predict interest rates and no one can predict how the stock market will perform. I'll also add no one has a clue what will actually happen when the Fed unwinds their bloated balance sheet.

 

[Gatordoc50]

The fed has been pretty straight forward. They warned us of both bubbles and yet most people ignored. My advice would be to listen to the fed and tune out everyone else.

 

[audreyh1]

I didn't take the time to find the source when I composed post #1, but I felt a tinge irresponsible doing it, and you've now (fairly) nudged me over the edge.

FWIW I suspect this is it, see fig3 on pg5 https://institutional.vanguard.com/iam/pdf/VIPS_Deficits.pdf ...

...in the section titled "Bond-market expectations: Often reasonable, but often wrong"

And that is in fact the same "Fed Funds futures market" that I referenced in my above post.

Their predictions may seem wacky - but guess what - they also appear to be much more conservative and gradual than the usual "pants on fire*" predictions dominating the headlines, and even they are far from accurate.

*"pants on fire" is how one of our regular posters on interest rates over at Morningstar likes to refer to many of the current loud market pundits who seem to be always be encouraging investors to panic.

As Gatordoc50 says - listen to the Fed. They are pretty much spelling things out in plain English. Ignore the spin - the spinners have something to sell.

After the last meeting, the Fed made it clear they are looking at inflation and unemployment rates, and that:

they would hold rates close to zero while the unemployment rate is above 6.5% as long as inflation is not projected to rise above 2.5%.

That is pretty specific.

 

[audreyh1]

As I recall, last time the Feds didn't target long term rates, that is, they were working the short end of the yield curve. This time with the "Twist," the long end was pulled down. Rates that were in the 5% range are now in the 3% range on the long end, at least a 2% drop. Whereas, rates on the short end are down less than 1%. If rates were to climb back to the "norm," long term bond funds could see a 10-20% drop in value, compared to under 5% for a short term fund.

Until recently - the Fed could ONLY target the shortest term rates.

Buying longer dated paper is very recent - something they only started doing well after 2008.

We really have no idea how the great unwind will happen and which duration bond will be hurt the most at each step. It will probably be a fairly gradual process.

 

[heeyy_joe]

We still have a long way to go before rates go up. IMO the key data and leading indicator will be housing starts. Check out the ten year chart:

US Housing Starts Chart

Housing is what almost sunk the economy, and whether the Fed signals so or not I firmly believe this is what they are watching. Only when housing starts crosses its ten year average (or is anticipated to) will interest rates rise.

 

[akck]

Maybe someday it will sink in; no one can predict interest rates and no one can predict how the stock market will perform. I'll also add no one has a clue what will actually happen when the Fed unwinds their bloated balance sheet.

Actually, it's easy to predict interest rates. The hard part is predicting when they will happen.

 

[akck]

Until recently - the Fed could ONLY target the shortest term rates.

Buying longer dated paper is very recent - something they only started doing well after 2008.

We really have no idea how the great unwind will happen and which duration bond will be hurt the most at each step. It will probably be a fairly gradual process.

True, but I look at it as an expansion of the same program. I agree it will be a very gradual process in order to minimize damage.