Visuallizing how a rate rise affects bond funds

[mathjak107]

while the fed may want to hold short term rates down it is investors that will determine the intermediate and longer end.

if you remember what happened when investors spooked and drove rates higher at the beginning of qe2 even the feds buying was no match for the pull of the worlds investors.

as your charts show changes in the fed funds rate may or may not effect longer term rates. but one thing is certain,when the investors of the world say its time its time.

 

[Lsbcal]

Khufu brings up an essential point.

Over on M* capecod occasionally updates us on what the futures predict about the Fed Funds Rate: End Q3 Market.-based Rate Predictions

What if the Fed doesn't start tightening until Q4 2015 - almost 3 years from now?
Fed funds rate 1% Dec 2016
Fed funds rate 2% Q4 2018
Fed funds rate 3% sometime after June 2022

That's a long drawn out process.

This is the sort of question that my spreadsheet tool is decent at. The first chart shows 3 funds with a 3 year ramp occurring after 1 year. The next chart shows the 3 year ramp occurring after 3 years.

BTW, I suspect in the case of both BOND and DODIX that the fund will change the duration during this 7 year period as a reaction to perceived rate changes. So the above constant duration simulations are just for comparison purposes.

Just from a standpoint of the bond fund investor, it would be better if the rate ramp occurs sooner and is faster rising. That assumes the bond fund investor stays the course over an extended period.

 

[mathjak107]

the real problem is historically a rise in short term fed funds rates has resulted in more times than not no corralation to longer term rates.

 

[Lsbcal]

the real problem is historically a rise in short term fed funds rates has resulted in more times than not no corralation to longer term rates.

From the Fed chart below, it looks like their is a correlation but it's not 1:1. In the case of the 2004 - 2006 rate rise, intermediate Treasuries started rising ahead of the 3mo Treasury (best controlled by Fed).

As I understand it, the Fed currently is controlling longer dated maturities but normally they do not do this. Caveat, I'm no expert.

 

[mathjak107]

interesting reading on the subject of corralation.

How to invest with interest rates so low - CBS News

 

[mathjak107]

whats interesting is bonds have been in a bull market for 36 years yet there have been at least 17 years where the fed increased interest rates at least 1% on the short end yet bonds rose.

in fact only 1 year did the fed raise short term rates 1% and intermediate term bonds fell , that was 1994.

thats very little corralation . but the reverse may be true and while all our eyes are on the fed it may not be the fed that lowers the hammer to the bond market.

it may come from left field from the worlds investors.