Your Views on Interest Rates

[Trooper]

With the Fed expected to announce its latest position on interest rates today, I was wondering what your view on rates in general is.

For example, as someone nearing or in retirement, should I be pulling for status quo to protect against bond price decease, or should I favor gradual rate increases as they will result in more favorable CD and fixed income investments into the future?

 

[HFWR]

Though generally and cautiously supportive of the Fed, I think exiting the QE mode, and allowing rates to find a more natural equilibrium is the prudent thing to do.

 

[pb4uski]

It doesn't really matter what you or I want. I think it is likely that interest rates will rise as the economy recovers which will temporarily hurt bond fund values. I have shifted my fixed income allocation towards fixed income investments with lower interest rate risk or investments that will recover any losses in value from changes in interest rates more quickly, mostly CDs, target maturity bond funds and short duration bond funds.

When I looked at it a few months ago my fixed income allocation had a duration of 2.2 and a yield of 2.4%. The yield is higher than one might expect given the duration because I target 19% of my fixed income to high yield bonds and 25% of my fixed income is in a PenFed 3% CD, so 44% is earning pretty good interest. This is somewhat offset by 12% in a MM awaiting investment opportunities and earning next to nothing.

 

[Mulligan]

Though generally and cautiously supportive of the Fed, I think exiting the QE mode, and allowing rates to find a more natural equilibrium is the prudent thing to do.

I was surprised to hear that "experts" said QE impacted rates by under 1%. I'm afraid for us income investors that a big uptick soon is not in the cards. But I guess then again, a 1% increase from a level of 2-3% is a huge percentage change. Although my opinion means nothing, I'm not terribly hopeful of finding a 5% CD anytime soon at any term length.


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[Cobra9777]

With the Fed expected to announce its latest position on interest rates today, I was wondering what your view on rates in general is.

For example, as someone nearing or in retirement, should I be pulling for status quo to protect against bond price decease, or should I favor gradual rate increases as they will result in more favorable CD and fixed income investments into the future?

I'm not sure it really matters in the long run, although I look forward to reading other opinions. All my fixed income exposure (except some municipal) is in tax-deferred accounts that I won't touch until RMDs kick in at 70.5, which is 17 years from now. So I'm not inclined to rush out and implement a short-duration strategy, based on this week's big news.

A couple things I HAVE done over the last few years to reduce the impact of rising rates include: (1) reallocated some fixed income to real estate, (2) delayed rebalancing into bonds as equities have rallied, (3) moved 20% of fixed income to high-yield corporates, and (4) held excess cash (Ally 0.87%) for opportunistic purchases in the event of another taper tantrum.

 

[HFWR]

I was surprised to hear that "experts" said QE impacted rates by under 1%. I'm afraid for us income investors that a big uptick soon is not in the cards. But I guess then again, a 1% increase from a level of 2-3% is a huge percentage change. Although my opinion means nothing, I'm not terribly hopeful of finding a 5% CD anytime soon at any term length.


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Relatively speaking, though, CDs paying 5% probably don't generate any higher real return than CDs at current rates.

 

[haha]

When I looked at it a few months ago my fixed income allocation had a duration of 2.2 and a yield of 2.4%. The yield is higher than one might expect given the duration because I target 19% of my fixed income to high yield bonds and 25% of my fixed income is in a PenFed 3% CD, so 44% is earning pretty good interest. This is somewhat offset by 12% in a MM awaiting investment opportunities and earning next to nothing.

This is excellent, as recently it has been hard to get yield that is numerically > duration.
Ha

 

[sheehs1]

For me the key is interest rate on our debt.- the United States that is. Currently at 1.7% (quoted by a finance guy this morning in a phone conversation). In order to raise rates we would have to be able to pay the increase rate on our debt. I don't see that any time soon. But I don't have a crystal ball. Not surprised by Yellen's stance today.

 

[LOL!]

I think i've set up my portfolio so that interest rates really don't matter much. To wit, the fixed income portion is divided up among an intermediate-term US bond index fund, a short-term corporate bond index fund (duration seems slightly longer than typical short-term bond funds), and some old TIAA traditional annuity units (currently paying me 4.76%).

And that fixed income portion is about a third of the portfolio or say 10 years of potential retirement expenses.

So as far as interest rates go, status quo is OK, raising rates is OK, and even falling rates is OK. It's nice not to have to worry about any of this.

 

[flyingaway]

I don't understand why people care so much about (the precise time) whether Fed will raise interest in Spring or in Summer 2015. Are they going to time the market and sell just before the interest raise?

 

[Lsbcal]

I don't know where rates are headed ... wish I did.

One chart that I update is the spread between 5yr and 3mo Treasuries. Others have said that when the spread is wide enough, it is OK to extend out in maturities. This is apparently part of DFA's bond strategy. This idea would seem to imply that it is OK to hold intermediate duration bonds now. Feel free to critique me on this one.

My intermediate bond funds are about 4 years duration. But I hold a minimum of bonds in favor of stocks, i.e. I'm not an "income investor". Eventually when we get to more historical real rates (maybe 2% on 10 year TIPS), I would increase my bond allocation.

Chart through August 2014 follows, right scale is the 5yr rate, left is the spread:

You can see when the spread got really narrow eventually we had a sudden sharp change (middle of 2013). In retrospect it might have been smarter to hold shorter term maturities then but you would have needed good timing skills (luck). From the chart low spreads can last for quite some time. Anyway that is past us now.

 

[LOL!]

I don't understand why people care so much about (the precise time) whether Fed will raise interest in Spring or in Summer 2015. Are they going to time the market and sell just before the interest raise?

I am sure somebody is going to try to time the market.

But suppose somebody comes into a windfall the day or week before the FOMC meeting. Should they invest all at once? Or should they wait until the day after the FOMC meeting? Or something else?

I am sure the forum will have plenty of "Invest now or wait until interest rates rise?" threads over the next few months.

 

[Mulligan]

Relatively speaking, though, CDs paying 5% probably don't generate any higher real return than CDs at current rates.

I imagine you are correct. Though it seemed in the past I could get rates significantly higher than inflation. Though I imagine it was more due to buying 5 year CD specials and then inflation rates bouncing lower after the CD was purchased.


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[Cobra9777]

When I looked at it a few months ago my fixed income allocation had a duration of 2.2 and a yield of 2.4%. The yield is higher than one might expect given the duration because I target 19% of my fixed income to high yield bonds and 25% of my fixed income is in a PenFed 3% CD, so 44% is earning pretty good interest. This is somewhat offset by 12% in a MM awaiting investment opportunities and earning next to nothing.

I'm curious how you calculated duration on the CD. Or did you assume zero?

 

[sengsational]

Wouldn't it be better to let interest rates be determined by the market so that there would not be such a big difference between the inflation rate and what someone can earn in a safe income producing instrument? It always seemed to me that manipulating the interest rate lower than it would normally be was simple theft by the government.

 

[pb4uski]

This is excellent, as recently it has been hard to get yield that is numerically > duration.
Ha

I'm curious how you calculated duration on the CD. Or did you assume zero?

I struggled with the duration to use for the CD and ultimately tossed up my hands and used zero because if interest rates change the value of the CD is unchanged. Same zero for the cash value of a whole life policy I own (which paid a tad over 4% last year) These "zero" duration investments represent about 28% of my total FI and help keep the overall weighted average duration low.

The high yield bonds also have a interest rate that exceeds their duration so that helps too.

 

[eta2020]

Wouldn't it be better to let interest rates be determined by the market so that there would not be such a big difference between the inflation rate and what someone can earn in a safe income producing instrument? It always seemed to me that manipulating the interest rate lower than it would normally be was simple theft by the government.

I don't think so.

It is one the tools that Fed uses to manipulate the economy and they had done pretty good job in 2009.

 

[Cobra9777]

I struggled with the duration to use for the CD and ultimately tossed up my hands and used zero because if interest rates change the value of the CD is unchanged.

Hmm. I need to ponder that further. Obviously, I can see where that is technically correct. But perhaps not the complete economic reality. If you are locked into a low-interest rate CD while rates are rising sharply... at some point, it will become beneficial to pay the penalty and lock in a higher rate. Did you not take that action because you were "losing money" on the interest rate? I'm certainly no expert in this area, but I think it's clear that CDs do have interest rate risk. I have no idea how to measure it, but duration=0 seems like an understatement.

Either way, your overall yield is impressive for that duration. I'm at 5.8 and 3.4% yield. I sure would like to get the duration down, but I can't stomach the yields on short-term bond funds and CDs. And I don't like timing interest rate movements any more than equities. I'd rather just minimize my fixed income exposure altogether until the dust settles. More likely, I'll just bump up the allocation to high-yield corporates a few more points, and try to maintain a long-term focus.

 

[mathjak107]

there is no link between the feds fund rate going up and effecting short term rates vs bond prices.

everyone has this belief that when short term rates go up all move in unison. actually they do not.

from 1980 to 2011 . more than 30 years only in 1994 did the federal funds rate

rise by more than 1 percent and intermediate bonds lose money. In fact, over

the last 36 years, we have seen a huge decline in interest rates.

Yet, there were almost as many years when the federal funds rate increased

(17) as there were years of decline. Yet, we only had one year (from 1973

through 2011) when the intermediate bond index produced negative returns..

no one can predict rates and try is foolish. if bill gross couldn.t get it right what chance do us mortals have.

 

[foxfirev5]

I agree that forecasting future interest rates is futile. All that you can do is manage the current situation and deal with the potential risks involved. Compelling arguments exist for both lower as well as higher interest rates ahead.

 

[pb4uski]

Hmm. I need to ponder that further. Obviously, I can see where that is technically correct. But perhaps not the complete economic reality. If you are locked into a low-interest rate CD while rates are rising sharply... at some point, it will become beneficial to pay the penalty and lock in a higher rate. Did you not take that action because you were "losing money" on the interest rate? I'm certainly no expert in this area, but I think it's clear that CDs do have interest rate risk. I have no idea how to measure it, but duration=0 seems like an understatement .....

Like I say, I struggled with what a good duration for my CD would be. I posed the question here and got a variety of responses. I would lose 6 months interest if I withdraw early so I can see the numerator being 1.5% (50% of 3% rate) but the question is how much of an increase would drive me to withdraw early? If 1% would incentive me to roll it over then the duration can be thought of as 1.5, if it s 2% then the duration could be thought of as 0.75. At the end of the day I figured that 0 was close enough since if I changed the 0 to .75 the weighted average only increase by .2

 

[OAG]

Personally I have found a couple of decent "fixed returns" somewhat recently:

1. PFCU: 10 year 5% APY CD Purchased 1/1/2010.
2. NFCU: 7 year 3.5-4.0% APY CD's Purchased in the 2011-2013 Timeframe.
3. PFCU: 7 Year 3.04% APY CD's (Several) Purchased in Jan/Feb 2014.
4. NFCU: 1 Year 5% APY CD's (Two) Purchased early this month.

These have been "deals" that did not result from holding idle Cash in a MM or other "0% or low interest account but the result of a long term (7 to 10 year) CD Ladder.

However, I personally doubt we will see routine CD's in the 5% APY range any time soon. It has taken about 6 or 7 years to get where we are now - hopefully it will not take 6 or 7 years to recover, but who knows?

 

[Mulligan]

Personally I have found a couple of decent "fixed returns" somewhat recently:

1. PFCU: 10 year 5% APY CD Purchased 1/1/2010.
2. NFCU: 7 year 3.5-4.0% APY CD's Purchased in the 2011-2013 Timeframe.
3. PFCU: 7 Year 3.04% APY CD's (Several) Purchased in Jan/Feb 2014.
4. NFCU: 1 Year 5% APY CD's (Two) Purchased early this month.

These have been "deals" that did not result from holding idle Cash in a MM or other "0% or low interest account but the result of a long term (7 to 10 year) CD Ladder.

However, I personally doubt we will see routine CD's in the 5% APY range any time soon. It has taken about 6 or 7 years to get where we are now - hopefully it will not take 6 or 7 years to recover, but who knows?

I am a CD kind of guy... Wanna take a gamble and trade your CD rates with mine behind door number #2?


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[brewer12345]

Personally I have found a couple of decent "fixed returns" somewhat recently:

1. PFCU: 10 year 5% APY CD Purchased 1/1/2010.
2. NFCU: 7 year 3.5-4.0% APY CD's Purchased in the 2011-2013 Timeframe.
3. PFCU: 7 Year 3.04% APY CD's (Several) Purchased in Jan/Feb 2014.
4. NFCU: 1 Year 5% APY CD's (Two) Purchased early this month.

These have been "deals" that did not result from holding idle Cash in a MM or other "0% or low interest account but the result of a long term (7 to 10 year) CD Ladder.

However, I personally doubt we will see routine CD's in the 5% APY range any time soon. It has taken about 6 or 7 years to get where we are now - hopefully it will not take 6 or 7 years to recover, but who knows?

Very astute buying, OAG. I have kind of decided that in today's fixed income environment it is probably wiser to be buying CDs that can be surrendered at a nominal penalty rather than bond/bond funds. I keep some allocation to bond funds to avoid outsmarting myself, but otherwise I do like you do and wait for Pen or Navy to get silly with CD rates as the tend to do from time to time. When they do offer up an opportunity, I grab it with whatever I can. I bought some of all the ones you listed. I have a maturity coming up in January and I will probably just sit tight and watch the two military credit unions for an opportunity to put the money back to work at an above market rate.