Fed lowers rate - bonds drop?

[soupcxan]

Normally when the fed lowers rates, the price of bonds increases. Yet today, every single Vanguard bond fund was down (including all treasuries across the yield curve). It can't be due to increase inflation expectations because their TIPS fund was down too. So what gives?

[freebird5825]

um..my best guess here is a delayed reaction due to the intense focus on hemorraging credit situation?

[Retire Soon]

I was unpleasantly surprised as well with the huge drop in bond fund prices today!

[Dawg52]

On an unrelated matter the Fed pours more money into AIG.

Fed grants AIG $37.8 billion loan - Yahoo! News

[statsman]

Quote:

Originally Posted by freebird5825 um..my best guess here is a delayed reaction due to the intense focus on hemorraging credit situation?

Sounds like you may be right and the bonds will recover quickly. At this point though, there seems to be no place to run, no place to hide.

[FIREd]

Quote:

Originally Posted by Retire Soon I was unpleasantly surprised as well with the huge drop in bond fund prices today!

I was as well! Wellesley dropped as much as Wellington today (1.38 % for both) while having about half the equity exposure of Wellington! I am getting seriously ticked off!

[freebird5825]

Quote:

Originally Posted by statsman Sounds like you may be right and the bonds will recover quickly. At this point though, there seems to be no place to run, no place to hide.

it was a purely logical guess...no crystal ball or expert lives here. these days, i almost (but not quite) prefer to see the smaller NAV losses YTD on my bond portion than what i'm seeing in my stock allocation.
the lesser of 2 evils and all that.
is this over yet?

[audreyh1]

Just goes to show you that even the highest rated paper is not immune to the credit squeeze - only US Treasuries went up today.

This has truly been brutal!

Audrey

[W2R]

Quote:

Originally Posted by FIREdreamer I was as well! Wellesley dropped as much as Wellington today (1.38 % for both) while having about half the equity exposure of Wellington! I am getting seriously ticked off!

Interesting. Stocks, bonds, banks, housing... everything is falling, and nothing seems to help. This is what they mean by the falling knife.

It has not yet sunk in for many people. I'm afraid there is going to be a lot of despair in the air by the time the falling knife finds a bottom.

[Gone4Good]

Quote:

Originally Posted by soupcxan Normally when the fed lowers rates, the price of bonds increases. Yet today, every single Vanguard bond fund was down (including all treasuries across the yield curve). It can't be due to increase inflation expectations because their TIPS fund was down too. So what gives?

It's actually a good sign. Treasuries have rallied during the crisis because they are a safe haven. Short-term treasuries are yielding close to zero . . . that is neither sustainable nor healthy. Today treasuries fell and real yields increased. Both are hopeful signs that risk-taking animal spirits are returning to Wall Street (if only grudgingly and slowly).

[socca]

Quote:

Originally Posted by soupcxan Normally when the fed lowers rates, the price of bonds increases.

This is an over-generalization. When the Fed lowers its target rate, it is usually sending a message that it wants to stimulate business activity, increasing the risk of inflation. In general, this is negative for bonds. However, the actual impact on a particular bond depends upon a host of other factors. The price declines we saw today aren't unexpected or unusual.

On a related note, Vanguard's Tax-Exempt Money Market is down to 4.82% today, from 5% and 5.5% on previous days. This is a good sign - let's hope this continues.

Here is Vanguard's muni fund yield curve for 10-08-2008:
+ money market: 4.82%
+ short-term: 3.17%
+ limited-term: 3.39%
+ intermediate-term: 4.09%
+ long-term: 4.57%
+ high-yield: 5.06%

I'll consider the 'credit crisis' over for munis when the money-market yield drops below the short-term yield. This inverted yield curve is very peculiar. I don't like peculiar.

[Ed at AAFR]

I believe it does have to do with inflation. I'm not entirely sure about the inflation protected bonds, although maybe they are simply part of a huge, generalized selloff.

In any event: the government and the Fed are creating liquidity by pouring money into the short-term market. This drives down short term yields. But it augurs ill for inflation, therefore long-term yields go up (and prices go down).

For what it's worth: I never cease to be amazed at the (still) relatively low yields for long term bonds. I wouldn't touch a 30 year bond with a ten foot pole unless it was yielding at least 8%, preferably 9%, with absolute safety. Think of what will happen to those bonds when the Chinese and others decide to stop buying so much of our debt <shudder>. It will make the recent plunge in the Dow look like a minor blip.

[Marquette]

On the plus side, it's helping keep asset allocation in line.

[audreyh1]

Quote:

Originally Posted by Marquette On the plus side, it's helping keep asset allocation in line.

Did I miss a wink smiley face?

I think you definitely want asset allocation to go out of line during time of financial upheaval so that you can rebalance. If all asset classes go down together you haven't gotten any benefit from diversification!


Audrey

[Gardnr]

Quote:

Originally Posted by Ed at AAFR For what it's worth: I never cease to be amazed at the (still) relatively low yields for long term bonds. I wouldn't touch a 30 year bond with a ten foot pole unless it was yielding at least 8%, preferably 9%, with absolute safety. Think of what will happen to those bonds when the Chinese and others decide to stop buying so much of our debt <shudder>. It will make the recent plunge in the Dow look like a minor blip.

Agreed. It makes you wonder who the heck is holding those 30 yr bonds with all that interest rate risk. Weird stuff sometimes.

[audreyh1]

According to Credit Analyst Tony Crescenzi (who is actually dancing a happy dance over this), it's very good news that today's that Treasury yields rose sharply, because it indicates a lessening of a the extreme "flight to quality" we've suffered lately - i.e. the first signs that the credit freeze is starting to thaw.

Audrey

[FIREd]

Quote:

Originally Posted by Gardnr Agreed. It makes you wonder who the heck is holding those 30 yr bonds with all that interest rate risk. Weird stuff sometimes.

If you bought individual bonds and held them to maturity, then you would only have to contend with credit and inflation risks (and only inflation risk if you bought treasuries). You wouldn't have to worry about interest rate risk.

The issue I have with buying long term treasuries right now is inflation risk. They just don't pay enough interests (4%) IMO to justify taking the risk.

[mathjak107]

not really true, if your getting 4% on a fixed bond and hold it to maturity in a 7% world conventional theory says you lost 3% because you didnt get it. dont forget also you may have paid above par on that bond when you bought it because of rates and now you reedem it at par

on the other hand the bond funds rate isnt fixed, if rates go up you get the higher rate although your principal drops . as you get towards the weighted maturity of both fixed or fund it gets pretty close.

its no differtent than owning a bunch of individual bonds with some maturing at different times and different rates

[OAG]

Quote:

Originally Posted by Dawg54 On an unrelated matter the Fed pours more money into AIG. Fed grants AIG $37.8 billion loan - Yahoo! News

I guess those Half Million Dollar Dollar Spa Visits take their toll. Just because "we own it" does not mean we have to keep pumping this thing up. Sell it to Mr. WB.

[socca]

Quote:

Originally Posted by socca Here is Vanguard's muni fund yield curve for 10-08-2008: + money market: 4.82% + short-term: 3.17% + limited-term: 3.39% + intermediate-term: 4.09% + long-term: 4.57% + high-yield: 5.06% I'll consider the 'credit crisis' over for munis when the money-market yield drops below the short-term yield. This inverted yield curve is very peculiar. I don't like peculiar.

Here is Vanguard's muni fund yield curve for 10-23-2008:
+ money market: 2.92%
+ short-term: 3.59%
+ limited-term: 3.80%
+ intermediate-term: 4.49%
+ long-term: 4.95%
+ high-yield: 5.50%

Although money market rates are now below short rates, it may be premature to call the 'credit crisis' over. At least, it has ameliorated somewhat. It's nice to see the yield curve looking more normal.

It may be that VG's muni funds have finally found a (temporary?) bottom after a few nasty weeks of free-fall. I noticed that VG's muni fund managers are sitting on quite a bit less unrealized losses than they have in the past, reflecting some appreciation in the bonds they're holding.

It looks to me like VG's short- and limited-term muni bond funds are a great buy now: for very little additional risk you get some great Federal-tax free income.

Disclaimer: my financial predictions are usually wrong. My advice is worth what you paid for it.