Bonds go down with interest rate hikes?

[Jerry1]

I looked in on the news today and of course the stock market was dropping. Said reason was due to interest rate hikes. Okay, I understand fear of inflation and such could impact business going forward. But when I opened my 401k later this evening, the bond fund FDNBX hardly went down at all (.13%) versus 2.12% for my S&P fund (FXAIX).

I don't know how to interpret this. Shouldn't the threat of interest rate hikes impact the bond fund significantly? Is the interest rate hike too small to register? Is the interest rate hike and the threat of inflation impacting the stocks disproportionally? Not looking for a mathematical algorithm but the difference in magnitude doesn't make sense to me.

Or, just be glad I have an AA where I didn't take a bigger hit today? If this is the program, seems silly to be in stocks or bonds. I think we're all expecting that interest rates are on the rise and if both asset classes are going to suffer, shouldn't the AA go a little heaver to cash for awhile?

 

[HadEnuff]

I don't think the "threat" of interest rates rising impacts the value of your bonds. When, indeed interest rates rise (if they do), THAT will have an impact on the principal.

 

[Cessna152]

I looked in on the news today and of course the stock market was dropping. Said reason was due to interest rate hikes.

Reporters who report on stock movements are required by an immutable law of the universe to insert an explanation for the movement. The same law makes no requirement that the explanation be remotely correct. Which is a good thing, since the markets are driven by the motivations of millions of stock and bond holders. You think it is difficult if you can't name your favorite color under penalty of being thrown into a bottomless gorge? Imagine being forced to explain market movements every trading day for your whole career.

 

[gcgang]

Yes, bonds go down with interest rate hikes. If 10 year Treasury rates rise from 2.5% to 3.5%, their value will decline by about 30%.

 

[Danmar]

I don't think the "threat" of interest rates rising impacts the value of your bonds. When, indeed interest rates rise (if they do), THAT will have an impact on the principal.

Bonds trade in a market. If the market starts to anticipate interest rate increases it will usually result in bonds trading for less. Not a question of principal as this will usually be returned at maturity, but rather market price now.

 

[tdv2]

Yes, bonds go down with interest rate hikes. If 10 year Treasury rates rise from 2.5% to 3.5%, their value will decline by about 30%.

30%? Can you show us the math you used to calculate the change in net present value of the 2.5% yield 10 year treasury bond vs the 3.5% yield 10 year?

 

[Finance Dave]

Another thing to consider is the "duration" of the bond fund, which you can usually find in the prospectus. THe longer the duration, the more it is impacted by a change in interest rates. Perhaps your bond fund has a relatively low duration?

 

[mathjak107]

Yes, bonds go down with interest rate hikes. If 10 year Treasury rates rise from 2.5% to 3.5%, their value will decline by about 30%.

that is not right . it is about 1% for every year outstanding with a 1 point difference . a 10 year would see about a 9% dip , not 30% if rates went up 1%

 

[tdv2]

that is not right . it is about 1% for every year outstanding with a 1 point difference . a 10 year would see about a 9% dip , not 30% if rates went up 1%

+1. Agree. Even a 30 year treasury (with 30 years to maturity) would only decline ~20% with a 1% move in interest rates off current levels.

 

[NW-Bound]

I looked in on the news today and of course the stock market was dropping. Said reason was due to interest rate hikes. Okay, I understand fear of inflation and such could impact business going forward. But when I opened my 401k later this evening, the bond fund FDNBX hardly went down at all (.13%) versus 2.12% for my S&P fund (FXAIX).

I don't know how to interpret this. Shouldn't the threat of interest rate hikes impact the bond fund significantly? Is the interest rate hike too small to register? Is the interest rate hike and the threat of inflation impacting the stocks disproportionally? Not looking for a mathematical algorithm but the difference in magnitude doesn't make sense to me...

Never own much bond, I looked at BND (Vanguard Total Bond) to see for myself. It went down 0.3% yesterday, nothing compared to stocks.

I think stocks got hit harder because they have been up so much recently, and the news were just a catalyst for people to start selling, then selling begets more selling.

Or, just be glad I have an AA where I didn't take a bigger hit today? If this is the program, seems silly to be in stocks or bonds. I think we're all expecting that interest rates are on the rise and if both asset classes are going to suffer, shouldn't the AA go a little heaver to cash for awhile?

If inflation is going to rise, one is going to lose 3% each year with cash, so that would not be good in the long term. In the short term, one can be OK but that's market timing, and one's result varies, as always.

 

[jim584672]

The spread between corporates and Treasuries is very small right now. With the rise in Treasury rates the spread should start to widen and prices for corporates will fall.

 

[Senator]

+1. Agree. Even a 30 year treasury (with 30 years to maturity) would only decline ~20% with a 1% move in interest rates off current levels.

That is a pretty HUGE move, and if rates go up even higher, 2%+, it will be worse.

 

[jim584672]

With the ultra low rates post-crisis all the markets are now priced with a very low discounting rate. In years past as the economy heated up the rates would rise and the markets could tolerate it. But now we will see how much the markets can tolerate a rate rise. It is like being on heroin for a decade, you can't just come off it quickly.

 

[Spanky]

That is a pretty HUGE move, and if rates go up even higher, 2%+, it will be worse.

A 2% increase in interest rate for 30 Years to maturity would drop the value by 32.75%. However, the drop is only 15.96% for 10 years to maturity.

 

[Senator]

A 2% increase in interest rate for 30 Years to maturity would drop the value by 32.75%. However, the drop is only 15.96% for 10 years to maturity.

I will assume your calculations are correct. Luckily, most people do not mind a 32.75% decline in their 'safe' investments, such as a T-bill.

A 15.96% decline would more likely be a welcome event by those with only a 10 year exposure.

And that is only 2% higher, we have already increased the Fed Funds rate over 1% during the past year or so.

 

[haha]

I will assume your calculations are correct. Luckily, most people do not mind a 32.75% decline in their 'safe' investments, such as a T-bill.



A 15.96% decline would more likely be a welcome event by those with only a 10 year exposure.



And that is only 2% higher, we have already increased the Fed Funds rate over 1% during the past year or so.

Great sarcasm, but way off factually. The longest t-bill is 52 weeks. The more common ones are 13 weeks and 26 weeks. The worst you could do in the 2 percent scenario in a 52 week bill is the difference between your purchase and redemption prices, less the 2 percent inflation. So currently that would be about (2-1.88) percent. Oh oh, a loss of 0.12 percent!

 

[gcgang]

that is not right . it is about 1% for every year outstanding with a 1 point difference . a 10 year would see about a 9% dip , not 30% if rates went up 1%

My bad. I was repeating what some idiot on CNBC said and was too lazy to check it. Glad someone out there is thinking for themselves.

 

[Senator]

Great sarcasm, but way off factually. The longest t-bill is 52 weeks. The more common ones are 13 weeks and 26 weeks. The worst you could do in the 2 percent scenario in a 52 week bill is the difference between your purchase and redemption prices, less the 2 percent inflation. So currently that would be about (2-1.88) percent. Oh oh, a loss of 0.12 percent!

I thought a T-bill used to be a lot longer? Mortgage bonds and some munis are 30 years?

Either way, many people think their bonds are exempt from going down after the 2008 stock market collapse. A raising interest rate environment will reduce principle balances on a bond almost every time.

 

[MichaelB]

I thought a T-bill used to be a lot longer? Mortgage bonds and some munis are 30 years?

Either way, many people think their bonds are exempt from going down after the 2008 stock market collapse. A raising interest rate environment will reduce principle balances on a bond almost every time.

Mr. Ha is reminding us of the difference beteeen Treasury notes, bills and bonds. In a discussion about interest rate sensitivity, it’s an important distinction.

It’s also important to keep in mind that when interest rates increase, the market value of a bond may decline, but the redemption value, payable on maturity, remains the same.

 

[tdv2]

I thought a T-bill used to be a lot longer? Mortgage bonds and some munis are 30 years?

Either way, many people think their bonds are exempt from going down after the 2008 stock market collapse. A raising interest rate environment will reduce principle balances on a bond almost every time.

Treasury Bills have maturity of 1 year or less. (T bills don't pay interest to maturity-- sold at a discount to face value)
Treasury notes have maturity ~2 to ~10 years.
Treasury Bonds have maturity ~10 to ~30 years.

 

[audreyh1]

My bad. I was repeating what some idiot on CNBC said and was too lazy to check it. Glad someone out there is thinking for themselves.

They do come up with some wild stuff on CNBC TV - especially their so-called guests. I turned it off long ago. I use their app for occasional glances at the markets and business headlines. Occasionally read an article which tend to keep to basic facts/reporting and not too much opinion. Much, much better!

 

[audreyh1]

Treasury Bills have maturity of 1 year or less. (T bills don't pay interest to maturity-- sold at a discount to face value)
Treasury notes have maturity ~2 to ~10 years.
Treasury Bonds have maturity ~10 to ~30 years.

So things can be simplified by calling them all Treasuries.

 

[Senator]

Mr. Ha is reminding us of the difference between Treasury notes, bills and bonds. In a discussion about interest rate sensitivity, it’s an important distinction.

It’s also important to keep in mind that when interest rates increase, the market value of a bond may decline, but the redemption value, payable on maturity, remains the same.

Great point, it's just that the spending power is greatly diminished when you redeem at maturity. And the entire time you owned it, the interest you collected was less than a comparable investment.

You put enough in to buy a case of beer, and when you redeem at maturity, you get enough back to buy a 6-pack.

 

[Danmar]

This thread has illustrated a significant lack of understanding of Fixed Income products and market. A little surprising given the usual competence of this group.

 

[tdv2]

Great point, it's just that the spending power is greatly diminished when you redeem at maturity. And the entire time you owned it, the interest you collected was less than a comparable investment.

You put enough in to buy a case of beer, and when you redeem at maturity, you get enough back to buy a 6-pack.

Your statement about the beer doesn't entirely ring true unless inflation goes off the charts.
You always get the face value back if you hold the note or bond to maturity (provided the issuer does not default). If you sell it before maturity, the value of the note fluctuates due to changes in interest rates or a change in the credit risk scenario. For the most part, short treasuries are considered risk free from the credit standpoint.

Here is an example:

You buy a 5 year treasury note that yields 2%. The price of this treasury note can be more, less or equal to the face value at the time of purchase (current market conditions determines price as you would expect). Each year you collect the 2% (coupon) on the original amount invested (in the case of treasuries the payout is every six months). At maturity, you receive the full face value of the note.

From the treasury direct web site.

• The yield on a note is determined at auction.
• Notes are sold in increments of $100. The minimum purchase is $100.
• Notes are issued in electronic form.
• You can hold a note until it matures or sell it before it matures.
• In a single auction, a bidder can buy up to $5 million in notes by non-competitive bidding or up to 35% of the initial offering amount by competitive bidding.