Are intermediate term interest rates CERTAIN to rise?

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Are intermediate term interest rates CERTAIN to rise?

Postby Calm Man » Sat Jun 29, 2013 1:05 pm

Apologies in advance as I have posted similar questions in the past, but my time for a fairly large bond fund purchase is next week per my IPS.
As I was out on a walk this morning listening (foolishly) to various AM radio preset stations, half the shows were financial in one way or another. EVERYBODY knows that the intermediate and long rates are going to go up and they all say beginning in the fall. This affects many of us in the holding or purchasing phase of investments (I am both). While we do know that at some point prior to the end of the world rates are likely to rise, we do not know when and we do not know how much. So even if we KNEW that the intermediate rates for example (currently around 2.5 - 2.75% in the Vanguard funds) were to rise to 5%, if this was in 100 years we would want to hold these funds. But if would be tomorrow, literally tomorrow, we wouldn't want them until after tomorrow.

So here is my question. I am assuming that all of the investment folks who KNOW rates are going up have sold and somebody who is not so outspoken is buying from them. Is it reasonable to assume that all knowledge is priced in and that these are fair rates or is it realistically possible that the artificial holding down of rates in fact is artificial and has to end soon? (Or would that be priced in too?)

This is of more than academic interest to me as I have a fairly large quarterly purchase of my tax exempt bond fund next week and some Int term investment grade in my IRA> Thank you.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby neurosphere » Sat Jun 29, 2013 1:09 pm

Calm Man wrote: So here is my question. I am assuming that all of the investment folks who KNOW rates are going up have sold and somebody who is not so outspoken is buying from them. Is it reasonable to assume that all knowledge is priced in and that these are fair rates or is it realistically possible that the artificial holding down of rates in fact is artificial and has to end soon? (Or would that be priced in too?)


Maybe this article will help: http://www.nytimes.com/2013/06/29/your- ... f=business

Making a bet on interest rates is no different from trying to predict the next big drop in stocks, or jumping into the market when it appears to be poised to surge higher. These sort of emotional moves are exactly why research shows that investors’ returns tend to trail the broader market.


and

“It’s a futile game to base portfolio moves on interest rate guesses,” said Milo Benningfield, a financial adviser in San Francisco. “We don’t have to look any further than highly regarded Pimco manager Bill Gross, whose horrible interest rate bet against Treasuries in 2011 landed him in the bottom 15 percent of fund managers in his category that year. Investors should take a strategic approach designed around the reason they hold bonds — and then sit tight whenever hedge funds and other institutions shake the ground around them.”


Regards, NS
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Chris M » Sat Jun 29, 2013 7:07 pm

In other words, stick with your IPS and proceed with your planned purchase.

Cheers,
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Kevin M » Sat Jun 29, 2013 7:40 pm

I don't know that any interest rates are certain to rise, nor when they might rise. I do know that there is a lot more risk on the downside from rising rates than potential gains on the upside from falling rates. The closer rates are to 0%, the more asymmetry in this risk/reward.

I manage this risk by having moved 2/3 of my fixed income to non-brokered CDs with decent early withdrawal terms. Because I don't know the future, I still keep about 1/3 of FI in intermediate-term investment-grade and muni bond funds.

Treasury bond funds make no sense to me since CD yields are higher for a given maturity, although that gap has narrowed in the last month. Owning something like TBM also makes no sense to me due to the large percentage held in treasuries, agencies, and MBS (unless you have no choice, for example in a 401k/403b). I understand that others have other reasons to own TBM, like simplicity and not having to think about alternatives, but these reasons don't apply to me.

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Re: Are intermediate term interest rates CERTAIN to rise?

Postby tadamsmar » Sat Jun 29, 2013 7:45 pm

Nope.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby nisiprius » Sat Jun 29, 2013 7:52 pm

Zeroth, a nod to Kevin M. What he has been saying all along makes good sense. I haven't been acting on his suggestions. When the dust settles I don't think I'm going to be terribly sorry I didn't, but he likely will have been right that I will have taken unnecessary interest rate risk and had to unnecessarily wait out a dip.

First of all, intermediate term interest rates are already rising. Depending on how far you think it might go, it is at least within the range of possibility that it might already be halfway there. Why do people keep missing this? I think it's because even if you double what's already happened, it still wouldn't be the great big hairy deal that people have been led to expect.

This is the 7-year Treasury rate, which corresponds roughly to the average maturity of Vanguard Total Bond.

Image

Will they keep rising? Oh, sure, probably, maybe. But in most cases though when you think it through, a prediction like that is really useless and not actionable intelligence unless you know a) when, and b) by how much.

The second point is that Vanguard published this stunning chart in one of their papers:

Image

It's an unfamiliar kind of chart so take a minute to look at it. The thick line is what interest rates really did. The thin "hairs" are what the futures market expected interest rates to do. Remember, these are markets, real people putting real money at stake, and all of the "wisdom of the crowd" behind it. Whenever the hairs are sticking out from the thick line like a bottle brush, it means the best predictions of interest rate movements were wrong by that much.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby peppers » Sat Jun 29, 2013 8:02 pm

Long Story. Short version. I moved 6 figures into the intermediate bond fund of my 401k last week. Don't ask. It's embarrassing.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby baw703916 » Sat Jun 29, 2013 8:03 pm

Image

The chart isn't correct for 2012...the Fed funds rate is still essentially zero, with no change contemplated in the foreseeable future. All that's currently happening is the Fed is contemplating when to wind down bond-buying to force down longer-term interest rates as well.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby nisiprius » Sat Jun 29, 2013 9:13 pm

baw703916 wrote:Image

The chart isn't correct for 2012...the Fed funds rate is still essentially zero, with no change contemplated in the foreseeable future. All that's currently happening is the Fed is contemplating when to wind down bond-buying to force down longer-term interest rates as well.
The chart only shows the actual rate up to 2011. That's the thick line, and it has not risen at the point when it ends. What you are seeing off the end is the "hair," the little microcharts of what the futures market was expecting the rate to be going forward, and showing that at up through, looks like early 2011, when the chart ends, the futures market was expecting the Fed to start raising rates long long before 2013.

You are correct. It hasn't happened yet. That rise at the end is not the actual rate, it is the futures market being wrong, wrong, wrong.

They should have made the "actual" curve a different color from the futures-market curves...
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby baw703916 » Sat Jun 29, 2013 9:48 pm

nisiprius wrote:
baw703916 wrote:Image

The chart isn't correct for 2012...the Fed funds rate is still essentially zero, with no change contemplated in the foreseeable future. All that's currently happening is the Fed is contemplating when to wind down bond-buying to force down longer-term interest rates as well.
The chart only shows the actual rate up to 2011. That's the thick line, and it has not risen at the point when it ends. What you are seeing off the end is the "hair," the little microcharts of what the futures market was expecting the rate to be going forward, and showing that at up through, looks like early 2011, when the chart ends, the futures market was expecting the Fed to start raising rates long long before 2013.

You are correct. It hasn't happened yet. That rise at the end is not the actual rate, it is the futures market being wrong, wrong, wrong.

They should have made the "actual" curve a different color from the futures-market curves...


OK, now that I look more closely, you are right, that was just another bad consensus. The conventional wisdom predicting that particular trajectory was so commonplace that it *looked* like a "thick" line.

The stupidity of crowds? :P
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Ged » Sat Jun 29, 2013 10:44 pm

Interesting that the preponderance of guesses are for higher stable rates regardless of what the actual rate is. Very few predictions of lower rates.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby stlutz » Sat Jun 29, 2013 10:52 pm

I suppose the thing to do is to consider all of the bad things that have a reasonable chance of happening that would cause a "flight to quality" in US treasury bonds. Are you sure the economy is going to improve and not slip into recession? What about the "interesting" times in places like Brazil? Etc. etc.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby gnav » Sat Jun 29, 2013 11:20 pm

This Vanguard paper is also worth a read.
July, 2010
Risk of loss: Should investors
shift from bonds because of
the prospect of rising rates?
http://www.vanguard.com/pdf/icrrol.pdf

I pull it out whenever I'm tempted to second-guess my allocation to interm-term bonds.
Then I go back to reading Boglehead postings.
Thanks everyone, for helping me stay on track.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Kevin M » Sun Jun 30, 2013 12:35 am

The Vanguard paper is fine for easing concerns about potential bond losses compared to potential equity losses, and repeating the well known fact that rising rates are good for bond investors in the long run, if all other fixed-income alternatives available to retail investors are not considered.

The paper mentions cash as an alternative that historically has not done well, but did it mention non-brokered CDs? No. Did it mention the fact that one can earn a higher yield from a CD than from a treasury bond (note/bill) of comparable maturity? No. Did it mention the fact that non-brokered CDs have much less interest-rate risk than bonds of comparable maturities? No.

Vanguard does not sell any non-brokered CD products, so why would they mention it?

Until the last month, a retail investor could even get a return on cash comparable to a 5-year treasury, but with no interest-rate risk, so I even think Vanguard's portrayal of cash is misleading. They use a 3-month treasury bill index as a proxy for cash, but this currently is not at all representative of what a retail investor can earn on cash.

Vanguard is my favorite vendor of mutual funds, but I certainly am not going to rely on their advice in this regard.

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Re: Are intermediate term interest rates CERTAIN to rise?

Postby heyyou » Sun Jun 30, 2013 12:51 am

I'm sure that rates will go up, and down, in the future.

I'm sure that I don't know when, don't know the direction, and that 30 years from now, 2013 won't matter. By then, I will have been just as happy and unhappy regardless of what rates did in 2013 and 2014. I will adapt to what I have then, ignoring what might have been if I had made some specific investment way back in 2014. The next gains and losses will both be insignificant in 30 years.

As in the Serinity Prayer, hope that you can recognize what you can control, and hope that you can adapt to the situations that you can't control.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby joe8d » Sun Jun 30, 2013 1:26 am

All I know is I bought some STIG last Monday @ 10.64 close to the lowest price ( 10.62, I bought then too) in 3 years.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby jupiter_man » Sun Jun 30, 2013 7:38 am

"Calm man" you qoute you are making a large Bond purchase.

Does it mean your current asset allocation has sigificantly deviated from your target allocation?
How much is this large Bond Fund purchase in % terms of your overall portfolio? Are you buying stocks at the same time?
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Calm Man » Sun Jun 30, 2013 11:01 am

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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Scooter57 » Sun Jun 30, 2013 11:19 am

The chart Nisi posted shows the impact of a black swan event, the Fed's QE which was an unprecedented intervention into the bond market. If you base your understanding of likely trends on it, you are acting like someone who refuses to buy stocks because of what happened in 2008.

The big question that KevinM alluded to is "What are you being paid to assume a significant risk right now?" Traditionally you were getting 2% or more over current real inflation rates to invest your money in bonds. That is far from the case now. So if there are less risky options paying within a percentage point of these risky ones, why invest in a vehicle with added risk not compensated for with commensurate return?
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby inbox788 » Sun Jun 30, 2013 11:27 am

Ged wrote:Interesting that the preponderance of guesses are for higher stable rates regardless of what the actual rate is. Very few predictions of lower rates.

Most guesses are revision to the mean, which is the correct direction, just the wrong timing.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Calm Man » Sun Jun 30, 2013 12:49 pm

Scooter57 wrote:The chart Nisi posted shows the impact of a black swan event, the Fed's QE which was an unprecedented intervention into the bond market. If you base your understanding of likely trends on it, you are acting like someone who refuses to buy stocks because of what happened in 2008.

The big question that KevinM alluded to is "What are you being paid to assume a significant risk right now?" Traditionally you were getting 2% or more over current real inflation rates to invest your money in bonds. That is far from the case now. So if there are less risky options paying within a percentage point of these risky ones, why invest in a vehicle with added risk not compensated for with commensurate return?



Scooter, as of this instant in time, the NJ muni long term bond fund (with duration of about 6 years) is yielding 2.75% fully tax free for Admiral shares. What comes within 1% of that and is safe on an after tax basis assuming a combined 40% rate or so as many muni investors are in? I am not disputing your assertion but wonder if the alternative really exists. I also pose the following dilemma---- if we are in a situation where rates stay about where they are for a really long time, like 10 or 20 years, the difference of 2% or so on a fairly large principal can be a lot right?
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby ogd » Sun Jun 30, 2013 1:14 pm

Calm Man, you are right that munis beat all other fixed income in a taxable account. In a high tax bracket / state, by a rather shocking margin.

The one thing to be aware of is that every now and then the fear of municipal defaults spikes and munis can take a trip south for a year or two, in value. This can be clearly observed in 2008 and 2010. So sometimes they will not be a good counterbalance to stocks like other, safer fixed income. This makes me uncomfortable with holding my entire taxable FI in munis, although they are clearly the most rewarding option in my case. I chose to complement it with a combination of cash and long term treasuries, enough to serve as rebalancing ammo for a year or two, because cash for small investors does yield more than short Treasuries. I am comfortable with the interest rate risk in the LT treasuries because, like you, I believe it has been baked into the market prices by people more informed than myself. One quick observation confirming this is that the noise about increasing interest rates is much louder than 6 months ago and the rates / prices have responded accordingly.

It might even be overbaked, like nisiprius' charts show it tends to be, but it's never safe to assume that the market is getting it wrong.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby mephistophles » Sun Jun 30, 2013 1:17 pm

Interest rates of all durations will go up. They also will come down again in the future. Then they will go up again. The cycle will repeat.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Scooter57 » Sun Jun 30, 2013 3:21 pm

Calm Man,

The advice to avoid long term finds is so universal that I would not want to ignore it unless I had a level of understanding of bonds and bond funds far greater than I have. Unless you really understand exactly what you are doing, relying on assurances of anonymous posters on a forum when investing a lump sum in a way most investment pros tell us is risky is probably a mistake.

My understanding is that the duration of a bond fund could change pretty quickly in response to market changes. And that is still a low rate, historically, for a long muni fund.

The fund must buy long bonds, so over time it will be locking in today's low rates for longer than intermediate bond funds. The duration may be low now because the fund still owns high coupon bonds from the good old days, but as they age out or are called they will be replaced with lower paying bonds.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby nisiprius » Sun Jun 30, 2013 4:03 pm

Scooter57 wrote:The chart Nisi posted shows the impact of a black swan event, the Fed's QE which was an unprecedented intervention into the bond market. If you base your understanding of likely trends on it, you are acting like someone who refuses to buy stocks because of what happened in 2008.
???? That chart goes back to 2000. QE1 began in 2008. The futures market was consistently wrong throughout the entire period, not just after 2008. And the errors were in both directions.

Just to be crystal clear: the reason I posted that chart was to make the point that nobody knows, and that anyone making confident-sounding statements about the future of interest rates should be ignored. However, I think it would be unwise at any time for an ordinary retirement saver to have a large holding in a long-term bond fund because the volatility is far higher than for intermediate-term funds, and the inflation risk is serious. I think it would be unwise to commit on any assumption that interest rates are not going to rise. Particularly since intermediate-term (and long-term) rates are already rising!
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Scooter57 » Sun Jun 30, 2013 4:09 pm

It was as lot wronger after 2008, though.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby baw703916 » Sun Jun 30, 2013 4:17 pm

Scooter57 wrote:It was as lot wronger after 2008, though.


Come on, you're saying that absent QE, the Fed funds rate would have started rising? If anything, it should be the opposite. Without the additional stimulus provided by QE (because the Fed funds rate was already zero), the rate would be staying at zero even longer than it currently will.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby ogd » Sun Jun 30, 2013 4:45 pm

So my bigger point was that one should not discount the credit risk in munis and the fact that they might not balance equity risk as well as other fixed income -- and it's equity risk that one really needs to worry about, always. But I see that this got lost in the chorus of disapproval for long-term bonds.

Let me clarify one thing -- I never said that one should hold only long term treasuries. I have an intermediate duration in credit risk -free fixed income that I chose to implement with cash and LT treasuries, taking advantage of FDIC-insured accounts on the short end. I know that the LTT's are volatile and I can deal with fluctuations in that portion of my FI. I simply do not believe that the LT treasuries are an unconditional bad deal.

Yes, I am an anonymous poster on a board. The barbell strategy is well known and documented, by people with letters afteir their names. But what difference does that make, really? Think of the aforementioned AM station hosts -- they announce their name loudly and proudly every 5 minutes, yet some of them (you know who) have been wrong about literally everything financial in the last five years. What can you do, knowing their name -- sue them? They don't even own up to their mistakes -- the latest trend is to blame the Fed for foiling their predictions with those mysterious policies hidden in plain sight.

Meanwhile, the bond market with money at stake and no agenda other than profit is telling me that VGLT is a good deal below $68 and a bad deal above $69. And I get a 10%-ish state tax discount to boot. So if there is a place for it in my portfolio, I see no reason to avoid it.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Scooter57 » Sun Jun 30, 2013 5:46 pm

Ogd,

I'm not suggesting your strategy is wrong, only that the OP needs to fully understand your arguments and those of others before deciding to follow it with his own money. And the emphasis is on fully. The time spent studying and opening the mind to conflicting arguments will pay off over time. I see a tendency to rush investment decisions that may lead to expensive mistakes. Brokers and advisors push people to invest large sums right away because it leads to bigger profits for them. People investong on their own have the luxury of taking their time.

I find it disturbing how people show up here, post questions about investing significant sums that make it clear they don't have much understanding, and there are always anonymous posters telling them what to do. The first thing people should be told is to never make any investment move they don't thoroughly understand. Then they need to research the record and credentials of anyone who gives them investment advice. Finally they need to know there are many investment topics on which reasonable, knowledgeable people can and do disagree.

It is the fact that so many people don't take the time to fully educate themselves that makes them victims of the TV pundits. Even following the site philosophy here is not a slam dunk if people do it ignorant of why it's a good approach and how it may need to change as their life circumstances change.
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Re: Are intermediate term interest rates CERTAIN to rise?

Postby Kevin M » Sun Jun 30, 2013 8:39 pm

Calm Man wrote:Scooter, as of this instant in time, the NJ muni long term bond fund (with duration of about 6 years) is yielding 2.75% fully tax free for Admiral shares. What comes within 1% of that and is safe on an after tax basis assuming a combined 40% rate or so as many muni investors are in? I am not disputing your assertion but wonder if the alternative really exists. I also pose the following dilemma---- if we are in a situation where rates stay about where they are for a really long time, like 10 or 20 years, the difference of 2% or so on a fairly large principal can be a lot right?

No doubt you get a higher yield on a state TE fund than on any safe investment, but why are you comparing the two? A TE fund is not a safe investment, it is a risky investment. Probably not near as risky as stocks, but still risky.

The question is how much risk do you want to take with your fixed income relative to the expected return?

I also like the higher yields of TE funds, but I don't like that much interest-rate risk, not to mention the credit risk, so I balance it by holding a large portion of my FI in non-brokered CDs.

Have you heard the saying often repeated here: take your risk on the equity side? I personally don't follow that, and I don't think many who say it really do either. Everyone picks a point somewhere on the risk/return spectrum that they're comfortable with, whether it's for their fixed income or their portfolio. Maybe a long-term TE fund is safe enough for you.

In support of the VG "long-term" TE funds, I really don't consider the VG LT TE funds "long term". A duration of 6 years is nothing compared to the 15 or more year durations of the VG LT investment-grade and treasury funds.

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Re: Are intermediate term interest rates CERTAIN to rise?

Postby The Wizard » Sun Jun 30, 2013 9:13 pm

Intermediate interest rates are DEFINITELY rising, this year if not next.
Mortgage rates are already off their recent lows.
Plan ahead for this now or just forgetaboutitall...
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