Why are bond prices and bond fund navs doing this?

[Graybeard]

We all know how bond math works - coupon goes up and the price of the bond goes down or the nav on a bond fund goes down and visa versa.

So inflation is spooking the equity market, wouldn't that drive demand for bonds or bond funds and if so then wouldn't higher demand mean the price would rise and the coupon should drop? Yet as inflation terrorizes the equity market, the coupons are rising and prices falling.

This is a generalization, maybe some types of bonds/funds (high yield?) are not behaving like this but corporate bond funds and treasury bond funds prices are dropping. I am more attracted to buying T bills vs being in a bond fund now as even in short duration bonds/funds are losing value due to nav losses.

Maybe it is because the Fed will increase the FOMC rate on Wednesday so coupons will rise making prices fall yet why doesn't supply and demand offset that? I'm sure there is an obvious answer or a complex answer (since bonds are somewhat mysterious).

[jebmke]

Large movements to cash maybe

[38Chevy454]

I think the threat of recession has all the markets in retreat. Even precious metals are down, at least today.

The place to be right now is staying in cash if you have it. Until after Wednesday's Fed announcement at least. But i think more pain is coming. See pending recession fears and potential stagflation for reasons to stay sitting on cash. Of course the question is when to jump in with your cash and what type of investment.

[NW-Bound]

Quote:

Originally Posted by Graybeard So inflation is spooking the equity market, wouldn't that drive demand for bonds or bond funds and if so then wouldn't higher demand mean the price would rise and the coupon should drop? Yet as inflation terrorizes the equity market, the coupons are rising and prices falling...

When inflation rises, interest rate goes up with it. Even if the Fed does not raise the discount rate, I think lenders would want a higher interest rate to compensate for the loss of value of their principal when you finally pay off the loan.

Say you have a bond with a principal of $100 that pays $2/year for the next 5 years. The borrower will return your $100 after 5 years. It means you will get $110 after 5 years.

If interest rate rises such that I can lend out $100 to someone who pays me $3/year, I will get $115 after 5 years.

If you now want to sell me your 2% bond, I will give you only $95 to make up for the lower interest your bond carries.

That's roughly how it works.

[njhowie]

Quote:

Originally Posted by Graybeard I am more attracted to buying T bills vs being in a bond fund now as even in short duration bonds/funds are losing value due to nav losses.

You just answered your own question.

[daylatedollarshort]

Real interest rates are -2.25%. To stop stagflation, Volker raised real interest rates to 4.4%. That means a potential 6.65% increase in interest rates if the Fed follows Volker's playbook - Jerome Powell’s Volcker Deficit by Stephen S. Roach - Project Syndicate (project-syndicate.org)

When interest rates go up, bond prices go down - "In general, the higher the duration, the more a bond's price will drop as interest rates rise (and the greater the interest rate risk. For example, if rates were to rise 1%, a bond or bond fund with a five-year average duration would likely lose approximately 5% of its value. - https://www.investopedia.com/terms/d/duration.asp

So you can do the math on what a potential 6% rise in rates would do to bond prices in funds with a 5 year duration or more. Individual bonds can be held to maturity and redeemed at par, or with inflation adjustments in the case of TIPS and I bonds. But the funds never mature.

This article from back in January explains it: These Are the Worst Income Investments for the New Year - "Knowing what to avoid can be as important as what to buy for investing. This week’s Barron’s featured the tenth installment of Andrew Bary’s perennially popular list of the best income investments for the coming year. So, as a counterpoint, here’s my take on the worst income investments for 2022. Hint: They’re all longer-term bond funds." https://www.barrons.com/articles/wor...ts-51641338869

[Graybeard]

Quote:

Originally Posted by daylatedollarshort Real interest rates are -2.25%. To stop stagflation, Volker raised real interest rates to 4.4%. That means a potential 6.65% increase in interest rates if the Fed follows Volker's playbook - Jerome Powell’s Volcker Deficit by Stephen S. Roach - Project Syndicate (project-syndicate.org) When interest rates go up, bond prices go down - "In general, the higher the duration, the more a bond's price will drop as interest rates rise (and the greater the interest rate risk. For example, if rates were to rise 1%, a bond or bond fund with a five-year average duration would likely lose approximately 5% of its value. - https://www.investopedia.com/terms/d/duration.asp So you can do the math on what a potential 6% rise in rates would do to bond prices in funds with a 5 year duration or more. Individual bonds can be held to maturity and redeemed at par, or with inflation adjustments in the case of TIPS and I bonds. But the funds never mature. This article from back in January explains it: These Are the Worst Income Investments for the New Year - "Knowing what to avoid can be as important as what to buy for investing. This week’s Barron’s featured the tenth installment of Andrew Bary’s perennially popular list of the best income investments for the coming year. So, as a counterpoint, here’s my take on the worst income investments for 2022. Hint: They’re all longer-term bond funds." https://www.barrons.com/articles/wor...ts-51641338869

Yep, I never owned a bond just bond funds and on financial talk radio shows I constantly heard them dissing bond funds for the past few years. Well in a decreasing rate environment, a fund will make money on the nav in addition to the dividend each month but this year opened my eyes to why a bond is better. Inflation will eat way at both a bond and a bond fund but with the fund you also lose principal with rising interest rates.

I guess demand for bonds or funds must adhere to the inverse relationship and demand won't drive up the price as typically is what demand does.

[Koolau]

If we're abandoning bonds, what will we use as ballast for our equities? Personally, I've always been fairly light on bonds and use various kinds of cash-like instruments (from CDs to MYGAs to I-bonds, etc.) What are others using or switching to?

[lawman]

Quote:

Originally Posted by Koolau If we're abandoning bonds, what will we use as ballast for our equities? Personally, I've always been fairly light on bonds and use various kinds of cash-like instruments (from CDs to MYGAs to I-bonds, etc.) What are others using or switching to?

I've always used bond funds but as others have pointed out that works okay until it doesn't..After watching my bond fund crater I finally bailed..I've been buying 3 month C.D's, Treasuries, muni's and corporates. Still don't know what I'll do as those mature.. At some point as rates rise bond funds might be okay again but who knows how high rates will go..I know those 30 day yields and distributions nearing 5% are interesting. Especially since I have no appetite for any long term individual bonds that lower than AA.

[daylatedollarshort]

Quote:

Originally Posted by Koolau If we're abandoning bonds, what will we use as ballast for our equities? Personally, I've always been fairly light on bonds and use various kinds of cash-like instruments (from CDs to MYGAs to I-bonds, etc.) What are others using or switching to?

I still have mostly fixed income. I'm not abandoning bonds, just the funds. I sold the bond funds early in the year and put most of the money in short term Treasuries until interest rates level off. I also have a TIPS ladder, stable value and some other odds and ends. I used to like floating rate funds but those are a bit scary to own with a possible recession coming up.

[Dash man]

Quote:

Originally Posted by Koolau If we're abandoning bonds, what will we use as ballast for our equities? Personally, I've always been fairly light on bonds and use various kinds of cash-like instruments (from CDs to MYGAs to I-bonds, etc.) What are others using or switching to?

Personally, I think this is the time to watch bonds closely. I’ve bought some short term treasuries and expect to roll them into longer terms as they mature. We also have high six figures in a flexible retirement annuity paying 2.25% that we can pull out to put into bonds over the next year or two. My hope is to lock in some good yields on long bonds before this is over.

[NW-Bound]

If you sell your old low-interest-rate bond at a loss, then use that money to buy a new bond with a higher interest rate, it comes out the same at the end.

The loss of principal with old low-interest bonds is real. Just because it is not realized does not mean it is not there.

[COcheesehead]

Quote:

Originally Posted by Graybeard Yep, I never owned a bond just bond funds and on financial talk radio shows I constantly heard them dissing bond funds for the past few years. Well in a decreasing rate environment, a fund will make money on the nav in addition to the dividend each month but this year opened my eyes to why a bond is better. Inflation will eat way at both a bond and a bond fund but with the fund you also lose principal with rising interest rates. I guess demand for bonds or funds must adhere to the inverse relationship and demand won't drive up the price as typically is what demand does.

I am confused you have posted in the muni thread about individual bonds you bought.

[jazz4cash]

It is supply and demand. You can see by looking around here on this board many bond investors, especially bond fund investors are pulling out of their positions in reaction to falling prices/ NAVs. Fund managers are forced to liquidate so prices fall further. People have generally misunderstood the risk of holding bonds, esp. bond funds.

Here is the lipper fund flow data for week ending 6/8/22

“Net outflows are reported for All Taxable Bond funds of -$2.793 billion, “

“Municipal Bond funds report net outflows of -$1.729 billion.”

Where is this money going, you ask?

“Money Market funds reported net inflows of $24.318 billion. “….from stock and bond funds.

[audreyh1]

I’m fine with bond funds because I hold them essentially forever. When people dump bonds or bond funds during the inevitable market cycles I’m usually buying more, unless stocks are getting hammered twice as hard as is happening now.

I hold cash, short-term bond funds and intermediate-term bond funds in my fixed income allocation. Anything with duration less than 18 months I treat as part of my cash allocation.

Right now cash and short-term bond funds are overweight compared to my target allocation, and so I’ve been pulling from them to buy some equity funds.

[Freedom56]

Keep in mind that bond funds are holding a lot of low coupon debt (i.e. 10 year corporate notes below 1.75% or 5 year notes with coupons of 0.80% as examples). Most individual bond investors would stay away from those low coupon bonds but funds are playing with other peoples money and don't care. So as rates rise bond prices fall to compensate. If you look at the average investment grade bond fund, they are trading well below their March 2020 lows. The main reason is that their holdings have rolled over to lower coupon debt over the past two years as money continued to flow in. The distribution rates on many bond funds are far too low relative to a zero risk treasury. So there will be more pain ahead. Bond funds are not bonds. Bond are not designed to trade like stocks. The volatility in bond prices that we are seeing over the past decade is primarily due to bond funds buying high and selling low. The losses are absorbed by the holder.

[COcheesehead]

Quote:

Originally Posted by jazz4cash It is supply and demand. You can see by looking around here on this board many bond investors, especially bond fund investors are pulling out of their positions in reaction to falling prices/ NAVs. Fund managers are forced to liquidate so prices fall further. People have generally misunderstood the risk of holding bonds, esp. bond funds. Here is the lipper fund flow data for week ending 6/8/22 “Net outflows are reported for All Taxable Bond funds of -$2.793 billion, “ “Municipal Bond funds report net outflows of -$1.729 billion.” Where is this money going, you ask? “Money Market funds reported net inflows of $24.318 billion. “….from stock and bond funds.

And all set to chase returns when the market inevitably turns back upward.

[Koolau]

Quote:

Originally Posted by audreyh1 I’m fine with bond funds because I hold them essentially forever. When people dump bonds or bond funds during the inevitable market cycles I’m usually buying more, unless stocks are getting hammered twice as hard as is happening now. I also hold cash, short-term bond funds and intermediate-term bond funds in my fixed income allocation. Anything with duration less than 18 months I treat as part of my cash allocation. Right now cash and short-term bond funds are overweight compared to my target allocation, and so I’ve been pulling from them to buy some equity funds.

Yeah, this is pretty much what I've been doing. Those who have sold because the bond markets have dropped seem to have locked in a loss - or am I thinking wrong? I hate that both equities and bonds are down, but I've got lots of cash (like) investments which only suffer from inflation losses. YMMV

[NW-Bound]

Bond sellers are practicing market timing. They wait for the interest rate to go up, then buy back in at a higher coupon rate.

What they miss out on the low interest rate for a short time they are out, they expect to make up more than that on a new bond with a higher interest rate.

I hold practically no bond and am not a bond trader, but the above would be my thinking.

[COcheesehead]

Quote:

Originally Posted by NW-Bound Bond sellers are practicing market timing. They wait for the interest rate to go up, then buy back in at a higher coupon rate. What they miss out on the low interest rate for a short time they are out, they expect to make up more than that on a new bond with a higher interest rate. I hold practically no bond and am not a bond trader, but the above would be my thinking.

Lower coupon bonds drop in NAV so you’d sell at a capital loss with hope that the new coupon makes up for that.