The effect of rising rates on Bond Funds

[mrfeh]

Definitely NO. Even the Fed doesn't know what the Fed is planning to do over the next couple years. I worked for a few years as the head of investment accounting for a life insurer and as a result spent a lot of time with the bond traders... they are very smart but they don't have that good of a crystal ball.

I didn't say they know what the Fed will do. I said they know what the Fed is planning to do, which they announce via their minutes after every meeting.

 

[OldShooter]

The fed does not determine the rates of corporate or treasury bonds. The market does.

True, but not particularly useful information. The goal of the fed is to move the market and market typically will oblige.

The people that buy and sell bonds for a living know everything you do (and more). They know what the Fed is planning to do over the next couple years and price things accordingly. ...

I didn't say they know what the Fed will do. I said they know what the Fed is planning to do, which they announce via their minutes after every meeting.

Your post implied that the traders had some kind of superior knowledge of the fed's plans. Now you say they don't. As Rick Ferri's "All About Asset Allocation" reminds us: "There is a classic saying on Wall Street, 'What everybody already knows is not worth knowing.' "

Think about bond trader superiority in another way: If there actually was a bond trader who could obtain information that would enable him or her to successfully predict the market, why would he or she be trading for someone else's account? We don't hear of a lot of rich, solo-practice bond traders.

 

[mrfeh]

True, but not particularly useful information. The goal of the fed is to move the market and market typically will oblige.



Your post implied that the traders had some kind of superior knowledge of the fed's plans. Now you say they don't. As Rick Ferri's "All About Asset Allocation" reminds us: "There is a classic saying on Wall Street, 'What everybody already knows is not worth knowing.' "

Think about bond trader superiority in another way: If there actually was a bond trader who could obtain information that would enable him or her to successfully predict the market, why would he or she be trading for someone else's account? We don't hear of a lot of rich, solo-practice bond traders.

I'm not arguing that bond traders have some insider info. I'm saying they have at least as much info, and very likely more, than some retail investor posting here.

People who think they know more than these folks are fooling themselves when they try to time the market.

 

[GTFan]

Here is an example I used in another thread, so skip this if you've read it. Both investors have $10K in a bond fund in January, 2022.

Investor A - Sells bond fund in Jan 2022, buys short term Treasuries in 2022, rebuys the bond fund in 2023 or whenever the Fed has signaled that rates have topped out. Has $10,300 to invest in the bond fund with interest from the Treasuries.

Investor B - hangs onto their $10K bond fund until the Fed signals rates are going to level off. Has $8,000 in her bond fund in 2023.

Both A and B start making money in bond funds again once the big rate increases have stopped, but A will make more than B, because A's starting balance is $2.3K more. The difference now is we know rates are going to go up all this year per the Fed with almost 100% certainty, which will push bond prices down. And the Fed will let us know well in advance when they plan to taper off the rate increases. You can follow a mantra or you can follow the math. I would be interested in seeing the math from anyone who sees a way where investor B is going to come out ahead of investor A.

This is the same argument that anyone can make about any aspect of market timing, no matter the investment.

 

[daylatedollarshort]

This is the same argument that anyone can make about any aspect of market timing, no matter the investment.

Most people never know what the stock market will do, and we often don't know a year in advance what the Fed has planned. This time we know what the Fed has planned in advance because they've told us. Or as Dr. Phil would say, for those hanging on to their bond funds, how's that been working out for you?

 

[mrfeh]

Most people never know what the stock market will do, and we often don't know a year in advance what the Fed has planned.

And everybody knows it.

What makes you think that information hasn't already been incorporated in prices?

 

[daylatedollarshort]

And everybody knows it.

What makes you think that information hasn't already been incorporated in prices?

I think the only logical thing to do at this point is revisit this thread in 6 months to a year. Or wait, or we could revisit these similar threads from three months ago and see how each of these positions has played out.

 

[mrfeh]

I think the only logical thing to do at this point is revisit this thread in 6 months to a year. Or wait, or we could revisit these similar threads from three months ago and see how each of these positions has played out.

If we're talking about whether to hold total bond or not, it should be revisited in about 7 years.

 

[daylatedollarshort]

If we're talking about whether to hold total bond or not, it should be revisited in about 7 years.

I don't see how 7 years that changes the outcome from the investor A and B example, but if you have a similar scenario with supporting math on how B could possibly come out ahead, I would be interested in seeing that.

 

[VanWinkle]

I think the only logical thing to do at this point is revisit this thread in 6 months to a year. Or wait, or we could revisit these similar threads from three months ago and see how each of these positions has played out.

3 months, 6 months, a year...... That's not exactly long term investing.
It may be timely for a trader to check his success, but most here are not
traders.

VW

 

[mrfeh]

3 months, 6 months, a year...... That's not exactly long term investing.
It may be timely for a trader to check his success, but most here are not
traders.

VW

I've let myself get sucked into another bond fund thread...

For those that are still looking to learn, I suggest reading bogleheads and/or watching this:

 

[RunningBum]

I moved some $ from total bond to other fixed income vehicles last summer. This afternoon I moved about a third of that back to total bond.

mrfeh, can you please explain these two moves vs. your other posts in this thread to stay the course and look much longer term on bond investments? That was a profitable move, as we now see, but it seems contrary with your other advice.

I've tiptoed back into bonds, moving about 5% of my fixed income money back to bonds after the latest fed rate hike.

 

[pb4uski]

I didn't say they know what the Fed will do. I said they know what the Fed is planning to do, which they announce via their minutes after every meeting.

Still wrong though. While the Fed telegraphs what it is contemplating doing in the near term... no way for "the next couple years" as you wrote... they don't even know that.

They respond to emerging economic information.

 

[mrfeh]

Still wrong though. While the Fed telegraphs what it is contemplating doing in the near term... no way for "the next couple years" as you wrote... they don't even know that.

They respond to emerging economic information.

Of course they respond to economic conditions. I never said their plans are written in stone.

What we have is their projections, which do go out 2+ years:

https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20220316.pdf

 

[mrfeh]

mrfeh, can you please explain these two moves vs. your other posts in this thread to stay the course and look much longer term on bond investments? That was a profitable move, as we now see, but it seems contrary with your other advice.

I've tiptoed back into bonds, moving about 5% of my fixed income money back to bonds after the latest fed rate hike.

While I am a very good boglehead when it comes to equities, I have tried to time the bond market a bit in the past. It worked out this time.

However, in late 2018 I moved from total bond to short term bond when rates were rising, which was exactly the wrong thing to do in hindsight.

So, I'm batting .500.

The reason I have been telling people to stay the course lately is because I get the impression people are panicking as a result of the precipitous drop in bond fund NAVs this year. Selling low is exactly what people should not do.

 

[aja8888]

Still wrong though. While the Fed telegraphs what it is contemplating doing in the near term... no way for "the next couple years" as you wrote... they don't even know that.

They respond to emerging economic information.

Yes, the FED is clearly reactive in it's policy making. They make a policy, implement it, and wait and see what happens. This has been there historical mode of operation.

"Our two goals of price stability and maximum sustainable employment are known collectively as the "dual mandate."1 The Federal Reserve's Federal Open Market Committee (FOMC),2 which sets U.S. monetary policy, has translated these broad concepts into specific longer-run goals and strategies.

Price stability

The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the Price Index for Personal Consumption Expenditures (PCE), is most consistent over the longer run with the Federal Reserve's statutory mandate. The Committee has also explicitly noted that the inflation target is symmetric and stated that it "would be concerned if inflation were running persistently above or below this objective.

Maximum sustainable employment

Many nonmonetary factors affect the structure and dynamics of the labor market, and these may change over time and may not be measurable directly. Accordingly, specifying an explicit goal for employment is not appropriate. Instead, the Committee’s decisions must be informed by a wide range of labor market indicators.

 

[OldShooter]

Yes, the FED is clearly reactive in it's policy making. They make a policy, implement it, and wait and see what happens. ...

What is the alternative?

 

[aja8888]

What is the alternative?

Forward planning...

 

[OldShooter]

Forward planning...

Huh? Example, please.

 

[Sunset]

...

For those that are still looking to learn, I suggest reading bogleheads and/or watching this:

.....

Thanks for the video.
In the video he says bond funds will fall in rising rates, and as the sell off old bonds and buy new higher bonds start returning more.

I sold my BND to avoid any more of the falling NAV value, and when the Fed stops raising rates, or after a couple of more increases in the rate, I'll possibly buy back into BND.
Meanwhile I'll avoid losing (already avoided) more value.
In the last month, BND has fallen nearly $3 , and over $1 of that drop was after the Fed announced the .5% increase in rates which everyone expected.

 

[daylatedollarshort]

In the last month, BND has fallen nearly $3 , and over $1 of that drop was after the Fed announced the .5% increase in rates which everyone expected.

As of March, the Fed members expected to have 7 increases in 2022, so we're just getting started on the rate increases -New Federal Reserve projections show six more rate hikes this year (cnbc.com).

 

[mrfeh]

Thanks for the video.
In the video he says bond funds will fall in rising rates, and as the sell off old bonds and buy new higher bonds start returning more.

I sold my BND to avoid any more of the falling NAV value, and when the Fed stops raising rates, or after a couple of more increases in the rate, I'll possibly buy back into BND.
Meanwhile I'll avoid losing (already avoided) more value.
In the last month, BND has fallen nearly $3 , and over $1 of that drop was after the Fed announced the .5% increase in rates which everyone expected.

You are assuming rates not controlled by the Fed will continue to rise.

As for your comment about the price of BND this week, correlation does not mean causation. As I have said many times, bond traders don't wait for the Fed to act before taking anticipated rate changes into account.

If you want evidence, just look at the price of BND this year before the latest rate change - it went from $84 to $76. During that time, the Fed raised overnight rates .25% and they were still buying bonds (QE).

Now, ask yourself why the price dropped so dramatically.

And with that, I'm out of another bond fund thread.

 

[Sunset]

You are assuming rates not controlled by the Fed will continue to rise.

As for your comment about the price of BND this week, correlation does not mean causation. As I have said many times, bond traders don't wait for the Fed to act before taking anticipated rate changes into account.

If you want evidence, just look at the price of BND this year before the latest rate change - it went from $84 to $76. During that time, the Fed raised overnight rates .25% and they were still buying bonds (QE).

Now, ask yourself why the price dropped so dramatically.

.....

I am assuming that as the Fed raises rates, other rates will rise. I see it all the time with mortgage rates as an example, usually within days of the Fed increase.
I also think if the Fed jacks up rates a lot to say 10%, that even credit card companies will raise their high 25% rates to a lot higher unless limited by law.

I did see BND fall from $84 to $76. Wish I had sold more earlier in the year. I wonder how much of the fall was from other issues, like the issues that caused stocks to fall at the same time (VTI 242 to 208). I think bond funds can change prices for many reasons beyond simply the Fed rate.

I may be stupid, but I think as the Fed raises the rate, the BND fund will tend to go down in value due to the interest rate pressure. Since the duration is about 6.9 yrs for the fund, in about a year as they replace a good portion with newer bonds (some of which will be at today's rates and in a year will look low) it will rise in NAV value. Maybe it will take 2 years to happen.

Perhaps it has already hit the low spot, as it was only this low back in 2008, but that was during a time of declining interest rates, so it had the backlog of higher rate bonds to push up it's relative value.

Exciting times..

 

[daylatedollarshort]

If we're talking about whether to hold total bond or not, it should be revisited in about 7 years.

If investor A has $10.3K in the bond fund in 1 year, and investor B has $8K, then in 7 years A will be still ahead of B.

 

[Dtail]

If investor A has $10.3K in the bond fund in 1 year, and investor B has $8K, then in 7 years A will be still ahead of B.

You have made multiple variations of this point and I agree with all of them and yes I fully understand the duration concept.