Rising Rates Are Not Likely To Trash Your Bond Returns

johnN

Rising Rates Are Not Likely To Trash Your Bond Returns


Tom Madell

http://funds-newsletter.com

Portfolio Strategy, ETF investing, Fund Holdings, fund research


Summary
Bond fund/ETF investors, and even most investment professionals, believe that rising Fed-controlled interest rates will likely sink your bond funds.
In this article, I show historical data that rising Fed Fund rates are not typically associated with falling bond fund NAVs.
Since bond prices may not suffer as investors tend to think, this suggests some strategy considerations for holders of funds such as VBTLX and BND.
Federal Reserve Building in Washington DC
pabradyphoto/iStock via Getty Images

The news is full of articles these days that the Federal Reserve Board, the government entity charged with setting short-term interest rates, is close to reducing its support for the economy, and subsequently, likely to raise interest rates in the not too distant future. While such a raise in rates (or a series of ones) is not going to be immediate, it now seems many of the Fed's prominent economists are projecting an initial raise as early as mid-2022 with additional rises forecast to follow.**

https://www.google.com/amp/s/seekingalpha.com/amp/article/4458480-rising-rates-are-not-likely-to-trash-your-bond-returns

Enjoy

hank

(Just glancing at the headline) - Rising rates alone should help your bond fund (as a higher rate of interest is earned / reinvested). How the fund’s NAV reacts as bond prices fall is a different matter. I’m not selling any bond funds. But it’s likely investor money is pouring out. So, near term there may be some negative consequences for those of us who stay put. Depends on your time frame, type of bond fund, and why you bought it to begin with.

JoJo26

The higher rates only benefit newer issues (at higher rates). The existing holdings (that have lower rates) become increasingly less attractive.

hank

JoJo26 said:

The higher rates only benefit newer issues (at higher rates). The existing holdings (that have lower rates) become increasingly less attractive.

Even if the fund holds floating rate securities / adjustable rate mortgages?

Crash

I hold bonds for ballast and income. I still like the ones I've chosen. My re-invested divs will continue to benefit me, long-term. If the divs go higher, I'll be happier. RPSIX. PRSNX. PTIAX. And PRWCX holds some bonds, too. And wifey's BRUFX.

msf

hank said:

JoJo26 said:

The higher rates only benefit newer issues (at higher rates). The existing holdings (that have lower rates) become increasingly less attractive.

Even if the fund holds floating rate securities / adjustable rate mortgages?

Possibly. ARM funds were being launched left and right in the early 90s. And then they began dropping like flies as intererst rates rose.

In 1995, directors of the T. Rowe Price Adjustable-Rate U.S. Government Fund voted to broaden its investment policy and to change its name to the T. Rowe Price Short-Term U.S. Government Fund.
...
While the original ARM fund concept may have been valid, Randall Merk, director of fixed income investments for American Century, says, the industry "badly overstated" the protection such funds can afford shareholders during periods of rising interest rates.

https://www.orlandosentinel.com/news/os-xpm-1997-06-22-9706201623-story.html

LewisBraham

A lot depends I think on how fast rates rise and how much. A gradual increase probably won't hurt bonds much. A rapid increase would. In a scenario where 10-year corporates yield 3% and new issues suddenly yield 6% because of an inflation or default panic, existing bonds yielding 3% would I believe crash hard. But if corporate bond rates gradually increased over a period of years to 6%, the bond market would have more time to adjust to the shift via the income it is already paying to counteract bond price declines and the gradual increase of higher yielding issues in the outstanding bond mix.

Sven

When was the last time the rate hike is more than 25 bp (or 0.25%) since Alan Greenspan? It is more likely the rate hike will be gradual and sustain for several quarters unless inflation persists.

LewisBraham

It's rare for a rate hike on the front end to be too large from the Fed. But rates can surge more in the middle maturity and long maturity part of the yield curve as they are market driven, not set by the Fed. Volcker was probably the last Fed guy to really hike rates a lot at once on the front end: https://en.wikipedia.org/wiki/Paul_Volcker

Sven

Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981.

I remembered my parents were buying CDs that pay double digit dividends. The inflation was very high in the 70-80's. This year the 10-year treasury has been steady rising over 1.50% as inflation way exceeded the 2% threshold. The consumer price is considerable higher than 2%.

davidrmoran

first do no harm, and all that

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AndyJ

Excellent wonk column from PK.

Old_Joe

Yes, I really like that guy.