With March 15th Federal Rate Hike, who bond prices did not fall.

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spandey
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With March 15th Federal Rate Hike, who bond prices did not fall.

Post by spandey » Thu Mar 16, 2017 10:57 am

I keep hearing that bond prices fall as rates go up. Why it is not happening with recent hikes?
Thanks

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Phineas J. Whoopee
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by Phineas J. Whoopee » Thu Mar 16, 2017 9:35 pm

Hi spandey, and welcome to the forum.

What you keep hearing is a misconception, all too often promulgated by the financial press who should know better.

The Federal Reserve System, the Fed, via its Federal Open Market Committee, decided to raise its target for the Federal Funds Rate by a quarter of one percent. The move was widely expected, based on earlier statements by committee members including the chair, Janet Yellen. These days the Fed is trying not to surprise anyone.

The Fed does not set bond yields, and that's the widespread misconception. Bond yields, specifically Yield to Maturity, YTM, are set by the market, not the Fed. Market participants expected the Fed Funds Rate increase, so they already took account of it. What they didn't expect was the FOMC's statement that future increases would be gradual. The general consensus was they would be aggressive. That point of view also was taken into account, and when the Fed said something unexpected it resulted in bond yields falling, rather than rising, which is the same thing as saying the prices of bonds which already have been issued going up.

It is true, as a fact of math, that when the yield of an aready-issued bond goes down its price goes up, and vice versa. The equation works in both directions. Tell us the yield of a bond that's already out there and we can tell you its price. Tell us its price and we can tell you its yield. It's simply a matter of math.

The rate the Fed changed, the Federal Funds Rate, only applies to the most creditworthy banks lending among themselves overnight, and the Fed only has strong influence, not complete control, over it. At the end of each business day some banks will find themselves with more cash on hand than federal regulations require, and some with less, just due to random fluctuations. The Federal Funds Rate is meant to be the average rate at which the banks ending the day with more than required lend the excess to those which ended the day with too little. The Fed measures and reports it daily. The Fed itself neither pays nor charges the Federal Funds Rate.

Changes in the Federal Funds Rate change business conditions for banks, which affect their choices about how much to charge for loans and to pay for deposits. Each bank makes its own decisions. It can take months for the effects of a Federal Funds Rate change to work their way through the economy.

Is that helpful?

PJW

livesoft
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by livesoft » Thu Mar 16, 2017 10:14 pm

spandey wrote:I keep hearing that bond prices fall as rates go up. Why it is not happening with recent hikes?
Thanks

Bond fund prices did fall since Feb 24 when many people figured out in advance what was going to happen.
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WolfgangPauli
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by WolfgangPauli » Thu Mar 16, 2017 10:22 pm

Tradeable markets are forward looking so the only explanation is that it was already fully priced in. In fact, if you saw, bonds rose in value and rates on the 10 year actually went down.. That must have been because the "market" was thinking the Fed would be even more aggressive - not necessarily in the interest rate but in the forward looking language.

BTW, this is why timing the market is a fool's folly. How do you know how much of the current value is real and how much is due to speculation? You don't. This is why the idea of sticking to your plan over the long run is the best thing and don't try to guess what the speculators are doing.

The other learning for me (I was on vacation so I actually watched Yellen' presser) was how tame all of this is. She is saying in 3 years we may be at 3% - still ridiculously low compared to history.
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Kevin M
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by Kevin M » Thu Mar 16, 2017 10:47 pm

spandey wrote:I keep hearing that bond prices fall as rates go up. Why it is not happening with recent hikes?
Thanks

I wrote a series of blog posts that addressed this topic in great detail. If you are interested, you can start with Part 1 and go from there: Bond Basics: Part 1.

Here are the last few paragraphs of Part 2 of the series, that setup the explanation that tries to answer your question in Part 3:

This brings us full circle to the observation I shared in Part 1, which was that a National Financial Capability Study found that only 28% of American adults understand the relationship between interest rates and bond prices. Here is the question as it was asked in the study:

If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?

Hopefully you are now in the 28% of American adults that can correctly answer, "Fall". Here is the explanation provided in the online quiz that asks the questions asked in the study:

When interest rates rise, bond prices fall. And when interest rates fall, bond prices rise. This is because as interest rates go up, newer bonds come to market paying higher interest yields than older bonds already in the hands of investors, making the older bonds worth less.

The example in this post went through some simple bond math that explains this. However, the question and answer in the study and online quiz are not very precise, and don't really accurately describe the relationship between bond prices and bond yields. The reason is that there are many different interest rates in our economy, and the only interest rate relevant to the price of a particular bond is the yield of bonds that are similar to the bond in question. I'll discuss this in more detail in Part 3 of this series.


I lay some more groundwork in Part 3, but Part 4 directly address the question you raised. Here's a short extract from that post:

The short answer is that changes in the FFR are not of particular concern, since the FFR is a very short-term interest rate, and as discussed in Part 3, yields of different terms to maturity can change by different amounts and even in different directions. There is no direct relationship between the change in the FFR and the change in yield of an intermediate-term or long-term bond or bond fund.

A dramatic example of this was the period between May 10, 2004 and September 1, 2005, during which the effective FFR increased from about 1% to about 3.5%, while the yield on the 10-year Treasury decreased from about 4.7% to about 4%. This is shown in the chart below.


Kevin
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TBillT
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by TBillT » Fri Mar 17, 2017 11:26 am

Some very talented economists such as Lacy Hunt (Hoisington) and Gary Shilling have been saying the 30-year bond bull market is probably still in tact. Although it will be good to see Hoisington first quarter newsletter to see how they feel right now. Shilling seems to have backed off a little bit recently, but his newsletter is pay only, so I do not know for sure. Its the "bond vigilantes" that often set the short-term price, these are big movers who control the markets by their sell (or buy) orders.

pbearn
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by pbearn » Sat Mar 18, 2017 12:33 pm

This stockcharts.com "Dynamic Yield Curve" is a nice way to see what's happened with yields at various durations over time:

http://stockcharts.com/freecharts/yieldcurve.php

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Phineas J. Whoopee
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by Phineas J. Whoopee » Sat Mar 18, 2017 1:19 pm

TBillT wrote:Some very talented economists such as Lacy Hunt (Hoisington) and Gary Shilling have been saying the 30-year bond bull market is probably still in tact. ...

How can there be a 30+ year bull market in securities which mature in less time? Had the "bull" market not happened bond investors would have received much more in returns, because yields would have remained higher. Price changes are only temporary, because as bonds approach maturity their market prices approach their face values. Who would pay much more, or accept much less, than $1000 for a 30-year $1000 face value bond that matures tomorrow?
PJW

TBillT
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by TBillT » Mon Apr 03, 2017 1:46 pm

Phineas J. Whoopee wrote:How can there be a 30+ year bull market in securities which mature in less time?
PJW


Sorry for the late response, but interest rates have been falling for ~35-years, so the total return on the 30-year long term bond (appreciation + interest) is enormous. If you say the total purpose of bonds is interest and not appreciation, then yes you miss out on a big part of the bond game.

samtex
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Re: With March 15th Federal Rate Hike, who bond prices did not fall.

Post by samtex » Mon Jun 19, 2017 1:06 pm

Thought I would post this link from Bloomberg about Fed Rate increase and their effect treasuries.

https://www.bloomberg.com/news/articles ... rate-hikes

Samtex

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