Moving from short- to long-duration bonds

[Oink]

Several years back I realized I needed to diversify more into bonds. Believing that interest rates at the time were near an all-time low, I stuck with short- and intermediate-duration funds, planning to move to longer durations - and higher yields - when interest rates were higher.

Well, they're certainly higher now, and my funds (VFSTX and BIV, for example) are down 10%-ish. Long-duration funds are down even more. I'd like to stick to my original plan of (eventually) moving to longer-duration funds, but I'm not sure of the best timing or strategy. I know that no one has a crystal ball, but does anyone have any thoughts on this? Rates may still climb for a while. I'm hesitant to sell my holdings while they're so depressed (I know - sunk cost fallacy), but then, the long term funds are even cheaper (relatively). Should I wait a bit? Start dollar-cost averaging into longer durations now? Move it all now?

 

[Montecfo]

You had a good strategy. Trouble was that anything other than the shortest duration or specialty funds dropped as rates rose in 2022. Bonds fell too so it is not a fund only thing.

Not sure what is right for you without more info. But for me I began extending durations using individual bonds which I expect to hold to maturity. So in essence, I have built a ladder which is over 8 years. The first tranche matures this month, so I will be looking to redeploy into bonds in the 5-8 year range. If you use the ladder strategy you straddle the issue of getting highest and avoiding lowest rates.

The Fed is signaling 2-3 more hikes this year, then cuts next year. Avoid the temptation to wait until the Fed is done-mid to long-term rates will drop. In my opinion, now is a good time to begin extending maturities.

Well last fall was best but this is second best.

The "Golden Period" thread is where people talk about individual bonds. There is also a "Bond Funds or Bonds?" Thread to talk about pros and cons of bonds and funds.

There are also threads on CDs and MM accounts.

All the best and good investing!

 

[COcheesehead]

If you are in bond funds and rates continue to climb, you we see more losses without the interest income from those funds to make up for it. So being early to switch will hurt you.
Rates are “supposed” to top out in June and then stay at an elevated level into 2024. Reality will likely be different.
If you were in individual bonds, I would suggest you ladder.
The yields on short term, ultra safe bonds now are 5%+. Something to consider.

 

[copyright1997reloaded]

I am on the more cautious side than Montecfo. At the current time, my weighted days to maturity is 234, so under one year. In reality, it is somewhat longer as I also own a few perpetual preferred issues (i.e. no stated maturity). While the Fed might actually do only 2-3 more rate hikes, that might be a mistake and cause inflation to surge again. (We are already seeing that in some of the recent data.)

As COcheesehead mentioned, if rates rise your bond fund NAVs will fall. It is simple math. If you buy an individual bond (set maturity rate), the value of the bond will fall if rates rise, but you will receive par value at maturity (assuming the issuer is still around to pay it).

I always try to remember, these aren't binary decisions. I can nibble at longer duration, think about a while, and maybe nibble again.

 

[SecondAttempt]

I am being very cautious with bonds and bond funds right now. The Fed is cranking up short term rates but there seems to be little effect on longer term rates. The markets still expect long term inflation to be around 2-ish percent based on TIPS spreads. With the 10-year close to 4% it is getting attractive but not when I can wait it out in a 52 week bill at 5+%

While inflation might be higher, what's my choice? Cash which is guaranteed to lose against inflation?

 

[DrRoy]

The Fed is signaling 2-3 more hikes this year, then cuts next year.

FWIW, I don't think that the Fed is signaling cuts at any point. That is more of a market hope.

 

[COcheesehead]

FWIW, I don't think that the Fed is signaling cuts at any point. That is more of a market hope.

Agree. No talk of cuts, only higher for longer.

 

[Montecfo]

FWIW, I don't think that the Fed is signaling cuts at any point. That is more of a market hope.

The Fed's dot plot show cuts as follows:

during 2024 100 basis points
during 2025 100 basis points
over longer run 50-75 basis points

and a "longer run" fed funds rate of 2.5%.

https://www.cmegroup.com/markets/in...trading/interest-rates/countdown-to-fomc.html

 

[MichaelB]

The Fed's dot plot show cuts as follows:

during 2024 100 basis points
during 2025 100 basis points
over longer run 50-75 basis points

and a "longer run" fed funds rate of 2.5%.

https://www.cmegroup.com/markets/in...trading/interest-rates/countdown-to-fomc.html

Is the Fed dot plot a statement of intention or an expression of expectation? I’ve always seen it as the latter. In other words, the outcome they expect based on the economic models they are using.

 

[Montecfo]

Is the Fed dot plot a statement of intention or an expression of expectation? I’ve always seen it as the latter. In other words, the outcome they expect based on the economic models they are using.

It summarizes the FOMC's outlook for the Fed funds rate.

"The dot-plots, according to the Fed, are based on FOMC members’ individual assessments of “appropriate monetary policy” to generate levels of economic growth and inflation that meet the central bank’s objectives: maximum employment and stable prices."

https://tickertape.tdameritrade.com...ed-policy-projections-with-the-dot-plot-17550

 

[COcheesehead]

The dot plot…
https://www.thebalancemoney.com/what-is-the-fed-dot-plot-416891

 

[Car-Guy]

FWIW, I don't think that the Fed is signaling cuts at any point. That is more of a market hope.

Agree. No talk of cuts, only higher for longer.

Agreed... "At this point", I do think we'll see at least two more (maybe even three) increases this year. My guesses, .50, .25, .25. Then I expect we will see a halt for possibly an extended period of time (~year) before any cuts start to appear. So to me, the questions are, when will the cuts start, how quickly will rates drop and how low will they go. Hopefully not as artificially low as they were held in past decade+ pre mid 2022.

Anyway, from my simple understanding, that's what the inverted yield curve is telling me.

 

[COcheesehead]

Agreed... "At this point", I do think we'll see at least two more (maybe even three) increases this year. My guesses, .50, .25, .25. Then I expect we will see a halt for possibly an extended period of time (~year) before any cuts start to appear. So to me, the questions are, when will the cuts start, how quickly will rates drop and how low will they go. Hopefully not as artificially low as they were held in past decade+ pre mid 2022.

Anyway, from my simple understanding, that's what the inverted yield curve is telling me.

And when rates drop, what will equities do?

 

[Car-Guy]

And when rates drop, what will equities do?

Directionally, probably many will rise to new highs as rates go lower. Why, "cheaper money and an inflated dollar". YMMV

 

[COcheesehead]

Directionally, probably many will rise to new highs as rates go lower. YMMV

I think the opposite. If the Fed lowers rates it’s because they need to kickstart the economy that they broke while raising rates.
Longer term, I think the drop in rates makes stocks go higher, but I see that as a 2 - 3 year result.
Pain in ‘23/‘24,

 

[Car-Guy]

I think the opposite. If the Fed lowers rates it’s because they need to kickstart the economy that they broke while raising rates.
Longer term, I think the drop in rates makes stocks go higher, but I see that as a 2 - 3 year result.
Pain in ‘23/‘24,

I said (directionally) and agree with that. It's timing.

 

[pb4uski]

Is the Fed dot plot a statement of intention or an expression of expectation? I’ve always seen it as the latter. In other words, the outcome they expect based on the economic models they are using.

Nobody knows nuttin'

All just a compilation of educated guesses that are 50% likely and 50% unlikely methinks... but still useful as a broad brush overall indicator.

 

[COcheesehead]

I said (directionally) and agree with that. It's timing.

Agree.

 

[Car-Guy]

Nobody knows nuttin'

All just a compilation of educated guesses that are 50% likely and 50% unlikely methinks... but still useful as a broad brush overall indicator.

Guilty as charged.

 

[MichaelB]

It summarizes the FOMC's outlook for the Fed funds rate.

"The dot-plots, according to the Fed, are based on FOMC members’ individual assessments of “appropriate monetary policy” to generate levels of economic growth and inflation that meet the central bank’s objectives: maximum employment and stable prices."

https://tickertape.tdameritrade.com...ed-policy-projections-with-the-dot-plot-17550

The dot plot…
https://www.thebalancemoney.com/what-is-the-fed-dot-plot-416891

Right, and thanks. I’m familiar with the dot plots, but am questioning what they really indicate. IMO it is not a forecast or an indication of how they plan to vote. It is each individual’s view of the evolution or outcome of current policy, ceteris paribus.

The dot plot has greater value when the economy is in equilibrium or steady state. When it is undergoing significant volatility, as it is now, I think the dot plot has less value, especially when forecasting a change in inflection.

Nobody knows nuttin'

All just a compilation of educated guesses that are 50% likely and 50% unlikely methinks... but still useful as a broad brush overall indicator.

Probably right ..

 

[dmpi]

Agreed... "At this point", I do think we'll see at least two more (maybe even three) increases this year. My guesses, .50, .25, .25. Then I expect we will see a halt for possibly an extended period of time (~year) before any cuts start to appear. So to me, the questions are, when will the cuts start, how quickly will rates drop and how low will they go. Hopefully not as artificially low as they were held in past decade+ pre mid 2022.

Anyway, from my simple understanding, that's what the inverted yield curve is telling me.

If you look at the historical 30 year chart if and when rates start dropping it take a long time to fall, maybe less that 1% per year. Nothing happens real fast here. My strategy is to go very short term like 3-6 months and wait for the Fed to either hold or start going down. And then I'll go long. I won't buy at the peak but I think I'll still have years of decent bond returns.

 

[Dash man]

Several years back I realized I needed to diversify more into bonds. Believing that interest rates at the time were near an all-time low, I stuck with short- and intermediate-duration funds, planning to move to longer durations - and higher yields - when interest rates were higher.



Well, they're certainly higher now, and my funds (VFSTX and BIV, for example) are down 10%-ish. Long-duration funds are down even more. I'd like to stick to my original plan of (eventually) moving to longer-duration funds, but I'm not sure of the best timing or strategy. I know that no one has a crystal ball, but does anyone have any thoughts on this? Rates may still climb for a while. I'm hesitant to sell my holdings while they're so depressed (I know - sunk cost fallacy), but then, the long term funds are even cheaper (relatively). Should I wait a bit? Start dollar-cost averaging into longer durations now? Move it all now?

Personally I avoid bond funds. They can only hurt you in a rising rate environment. I suggest either using individual bonds/CDs/Treasuries where you can get your full principal back, or a money market fund that pays a decent interest rate.

 

[Car-Guy]

If you look at the historical 30 year chart if and when rates start dropping it take a long time to fall, maybe less that 1% per year. Nothing happens real fast here. My strategy is to go very short term like 3-6 months and wait for the Fed to either hold or start going down. And then I'll go long. I won't buy at the peak but I think I'll still have years of decent bond returns.

As they say, past performance is no guarantee of future results, but I still generally agree. At this stage of my life, I probably won't buy anything greater than a 3 year maturity. 1 and 2 years are better. I'd like to be here to collect and spend it.

 

[Montecfo]

Rates rose at quickest pace in history. Doesn't mean they will fall quickly. Also doesn't mean they won't.

But here is the tough thing about a Fed "pivot". Once the market gets clarity that Fed Funds rates will no longer drive, you are too late to capture the best rates. Mid-term rates will fall at that point.

My guess is the next key inflection point is when jobs begin to falter. Bonds will rally and rates fall immediately.

We get jobless claims weekly and a new jobs and unemployment report monthly.

Hence, laddering.

 

[dmpi]

Rates rose at quickest pace in history. Doesn't mean they will fall quickly. Also doesn't mean they won't.

But here is the tough thing about a Fed "pivot". Once the market gets clarity that Fed Funds rates will no longer drive, you are too late to capture the best rates. Mid-term rates will fall at that point.

My guess is the next key inflection point is when jobs begin to falter. Bonds will rally and rates fall immediately.

We get jobless claims weekly and a new jobs and unemployment report monthly.

Hence, laddering.

It's almost impossible to time this and somehow buy at the peak. But if you look at historical charts the peaks are more or less balanced on the left side and the right side. It goes down the same speed it goes up. So I don't think there's tons of money waiting to jump into the bond market...but who knows maybe there is this time.

Best case would be as you mentioned unemployment driving the pivot. But I also fear something like a banking collapse driven by home and auto loan defaults. If that happens rates will fall real fast.