Market Timing Bonds vs. Money Market with Rising Interest Rates

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ejm009
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Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by ejm009 » Sat Aug 04, 2018 8:17 pm

All
If I assume that interest rates are somewhat based on underlying government policy that seems to have some level of forecast, is it a bad idea to move pre-tax (401k, tIRA) investments between total bond and money market as some sort of slow movement market timing for fixed income ?
Thank You

livesoft
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by livesoft » Sat Aug 04, 2018 8:21 pm

I find that bond market timing is not for slow movers. Relatively large jumps/drops of 0.5% happen in a few hours. So I don't think the market timing that you wrote about makes sense.

If you want to time bond funds, then write down what you will do when the bond ETF BND drops by 0.4% or more in less than a day and what you will do when the bond ETF BND jumps by 0.4% or more in less than a day.
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bgyt
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by bgyt » Sat Aug 04, 2018 8:30 pm

ejm009 wrote:
Sat Aug 04, 2018 8:17 pm
All
If I assume that interest rates are somewhat based on underlying government policy that seems to have some level of forecast, is it a bad idea to move pre-tax (401k, tIRA) investments between total bond and money market as some sort of slow movement market timing for fixed income ?
Thank You
Not an expert, but this sounds like a fair question at the Macro Level - Since MM rates go up as interest rates increase (which is current Fed policy) and bond funds weaken as interest rates increase. I can clearly see my Vanguard Bond funds weakness since the Fed announced and I'm enjoying my VMMXX go above 2% to no surprise.

The correlation is real at the macro level right?

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Taylor Larimore
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Interest Rate Forecasters

Post by Taylor Larimore » Sat Aug 04, 2018 8:40 pm

ejm009 wrote:
Sat Aug 04, 2018 8:17 pm
All
If I assume that interest rates are somewhat based on underlying government policy that seems to have some level of forecast, is it a bad idea to move pre-tax (401k, tIRA) investments between total bond and money market as some sort of slow movement market timing for fixed income ?
Thank You
ejm009:
"There are only two kinds of interest-rate forecasters: Those who don't know, and those who don't know that they don't know." John Kenneth Galbraith
Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by bgyt » Sat Aug 04, 2018 8:53 pm

I honestly don't get it "at the Macro Level". When the Fed announces that we are finally raising rates (2016), is it not clear to everyone that we will most likely be in a 2-4 year window of increasing interest rates? I certainly wouldn't try to time individual hikes, but the business cycle is the business cycle, and why is it wrong to change AA based on an open governmental policy announced and hinted at by the Fed.

Don't get me wrong, I'm not asserting that I am correct, I honestly want to learn what I'm missing.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by z3r0c00l » Sat Aug 04, 2018 8:57 pm

bgyt wrote:
Sat Aug 04, 2018 8:53 pm
I honestly don't get it "at the Macro Level". When the Fed announces that we are finally raising rates (2016), is it not clear to everyone that we will most likely be in a 2-4 year window of increasing interest rates? I certainly wouldn't try to time individual hikes, but the business cycle is the business cycle, and why is it wrong to change AA based on an open governmental policy announced and hinted at by the Fed.

Don't get me wrong, I'm not asserting that I am correct, I honestly want to learn what I'm missing.
They will raise rates until they won't. There have been plenty of times where rate predictions were found to be wrong. A recession could start tomorrow, and rates can go back down again. Importantly, the very short term fed rates don't control longer term bonds.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by hdas » Sat Aug 04, 2018 9:02 pm

livesoft wrote:
Sat Aug 04, 2018 8:21 pm
I find that bond market timing is not for slow movers. Relatively large jumps/drops of 0.5% happen in a few hours. So I don't think the market timing that you wrote about makes sense.

If you want to time bond funds, then write down what you will do when the bond ETF BND drops by 0.4% or more in less than a day and what you will do when the bond ETF BND jumps by 0.4% or more in less than a day.
Mr. Livesoft,
I like your style, but why bother messing with BND for those kind of intraday maneuvers when you have liquid, cheap treasury futures (ZN or ZB) and taxed more favorably???
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by livesoft » Sat Aug 04, 2018 9:08 pm

^Go for it! :)

I will say that I am writing about timing other people's incorrect market timing moves and not really timing the bond market itself. The only prediction made is that if the bond prices move that much that fast, then they will probably (no guarantee) move back the other way when people come to their senses.
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bgyt
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by bgyt » Sat Aug 04, 2018 9:13 pm

Image

The Fed doesn't change directions for just one move. This trend was more than 50% likely to occur based on the initial move North. Again, I'm asking from a macro business cycle 2-4 year perspective not a daily/weekly perspective.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by vineviz » Sat Aug 04, 2018 10:22 pm

bgyt wrote:
Sat Aug 04, 2018 9:13 pm
Image

The Fed doesn't change directions for just one move.
Except when they do.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Dandy » Sun Aug 05, 2018 7:17 am

The Fed under the past and current leader has been fairly consistent about gradual rate rises over the past several years. Their actions have somewhat predictable market reactions. They are not like market gurus who are guessing at what rates will be -- they actually change rates. The Fed has made a point of not having any major surprises so they don't spook the market. So, while there are no guarantees, I think they will signal ahead of time when their approach is changing.

I don't think long term investors have to do anything since over a relatively short time bond funds should recover and their dip in value usually pales compared to equity risk. That being said I see no problem if some investors want to make modest adjustments to their fixed income choices. e.g. Retirees with large fixed income allocations might look to some fixed income diversity -- without being concerned about being a naughty market timer. A 2+% on a money market, savings account, or short term CD can help offset a 1 or 2% dip in their intermediate bond fund holdings.

For many the goal of their fixed income is safety and stability vs growth/risk which is taken on the equity side. If that is the case many fixed income choices will satisfy that goal. A real concern is that unplanned changes to your approach, like shifting some fixed income e.g. from Total Bond to a short term CD, might lead you to do more fiddling with your approach and you will become more of a market timer vs an investor. So you should have a plan to return to your original approach.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by MikeG62 » Sun Aug 05, 2018 7:30 am

z3r0c00l wrote:
Sat Aug 04, 2018 8:57 pm
bgyt wrote:
Sat Aug 04, 2018 8:53 pm
I honestly don't get it "at the Macro Level". When the Fed announces that we are finally raising rates (2016), is it not clear to everyone that we will most likely be in a 2-4 year window of increasing interest rates? I certainly wouldn't try to time individual hikes, but the business cycle is the business cycle, and why is it wrong to change AA based on an open governmental policy announced and hinted at by the Fed.

Don't get me wrong, I'm not asserting that I am correct, I honestly want to learn what I'm missing.
They will raise rates until they won't. There have been plenty of times where rate predictions were found to be wrong. A recession could start tomorrow, and rates can go back down again.
Perhaps the reason why short-term MM rates have been creeping up every time the Fed announces a rate hike and why they did not adjust all at once at the time the Fed announced they were embarking on a process to return rates to more normal levels over time a year or two ago.
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Call_Me_Op » Sun Aug 05, 2018 11:25 am

ejm009 wrote:
Sat Aug 04, 2018 8:17 pm
All
If I assume that interest rates are somewhat based on underlying government policy that seems to have some level of forecast, is it a bad idea to move pre-tax (401k, tIRA) investments between total bond and money market as some sort of slow movement market timing for fixed income ?
Thank You
Yes, we call that market timing. It is usually a bad idea.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by bgyt » Sun Aug 05, 2018 11:54 am

Call_Me_Op wrote:
Sun Aug 05, 2018 11:25 am
ejm009 wrote:
Sat Aug 04, 2018 8:17 pm
All
If I assume that interest rates are somewhat based on underlying government policy that seems to have some level of forecast, is it a bad idea to move pre-tax (401k, tIRA) investments between total bond and money market as some sort of slow movement market timing for fixed income ?
Thank You
Yes, we call that market timing. It is usually a bad idea.
To help the OP, can you specifically explain why it is a bad idea in this narrow case.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Dead Man Walking » Sun Aug 05, 2018 3:38 pm

Like many posters here, my bond investments are short-term bonds because I prefer to take risk with equities. In the current environment, I'm putting new money in money market funds rather than bond funds. I'm basing my decision on recent total return numbers. If this is market timing, I'm guilty. If it's chasing performance, I'm also guilty.

DMW

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by grabiner » Sun Aug 05, 2018 9:57 pm

bgyt wrote:
Sat Aug 04, 2018 8:53 pm
I honestly don't get it "at the Macro Level". When the Fed announces that we are finally raising rates (2016), is it not clear to everyone that we will most likely be in a 2-4 year window of increasing interest rates? I certainly wouldn't try to time individual hikes, but the business cycle is the business cycle, and why is it wrong to change AA based on an open governmental policy announced and hinted at by the Fed.
There is more than one interest rate. The Fed sets a target for short-term rates, but it doesn't directly affect long-term rates. Bond yields are determined by bond traders, based on their expectations of future economic conditions; they already know about the Fed policy, and trade at prices which reflect it. The yield of a five-year bond should be equal to bond traders' expectations of short-term rates over the next five years, plus a premium for the risk.

In 2016, long-term rates were much higher than short-term rates, because bond traders expected short-term rates to increase considerably over the next few years. Most of those rises have now happened, so short-term rates rose more than long-term rates in the last two years, but long-term rates are also higher than they were in 2016.
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Kevin M » Sun Aug 05, 2018 10:13 pm

grabiner wrote:
Sun Aug 05, 2018 9:57 pm
There is more than one interest rate. The Fed sets a target for short-term rates, but it doesn't directly affect long-term rates.
This is the key to understanding. Here is a graphic demonstration of this:

Image

Note that despite a large increase in the federal funds rate (FFR) from June 2004 through Jan 2006, the 10-year Treasury yield decreased. So even though it is highly probable that the Fed will increase the FFR, that doesn't necessarily mean that longer-term yields also will increase.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by patrick013 » Mon Aug 06, 2018 11:44 am

grabiner wrote:
Sun Aug 05, 2018 9:57 pm
The yield of a five-year bond should be equal to bond traders' expectations of short-term rates over the next five years, plus a premium for the risk.
And the same is true for 10 and 20 year TRSY's. The
sellers are doubtful. Why should they lower the prices
based on short term rates that haven't risen yet or ever
will ? The FFR and other short term rates would have
to hold steady for quite some time for the long term rates
to reach levels of 6-7% even 8% like they have in decades
past with average term spreads.

All we have right now is short term aberration, incomplete
information, and a yield curve that doesn't know whether to
go up or down.

Now that short term rates are actually going up the only thing
to do is nothing. How high and how long they will stay up
is to be seen.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by goodenyou » Mon Aug 06, 2018 4:52 pm

I get it. We look for stability in bond funds and the erosion in NAV in a rising interest rate environment troubles us. The fallacy is that we can predict the direction of bonds because we correlate rising interest rates with a decline in NAV. This is especially true for longer duration bonds. Therefore, the error is that we can get in and out of the bond funds in a predictable way to juice returns. It, unfortunately, doesn’t work that way. If you keep buying bond funds with new money dollar cost averaging and reinvesting dividends, you accumulate more shares on the dips. It’s just like stocks. It’s just hard to get your head around it because “it’s bonds”. Your need in time to deploy the asset should guide decisions.
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Counterpoint » Mon Aug 06, 2018 7:28 pm

grabiner wrote:
Sun Aug 05, 2018 9:57 pm
Bond yields are determined by bond traders, based on their expectations of future economic conditions; they already know about the Fed policy, and trade at prices which reflect it. The yield of a five-year bond should be equal to bond traders' expectations of short-term rates over the next five years, plus a premium for the risk.
To expand on grabiner’s point: Interest rates already have current expectations about future Fed rate increases priced in. So that means you don’t get a free lunch by moving funds from bonds to money markets just because rates are going up. The real question is whether rates go up by more or less than the expectations that are already priced into the market.

As a hypothetical example, if market expectations are that the Fed will tighten policy by raising the overnight fed funds rate (they rate they control) by 50 bp at the next Fed (FOMC) meeting, but let’s say it turns out that they only raise the fed funds rate by 25 bp because the Fed’s analysis showed the economy was not heating up as much as was thought earlier. Then in all likelihood shorter term rates (e.g. 1 or 2 year rates) would actually decline immediately after the Fed increases the Fed funds rate by 25 bp. So this is an example where shorter term bonds would actually rally (decrease in yield and increase in price) even though the Fed increased rates.

The bottom line for the OP is that just because you know the Fed is going to increase interest rates, that’s not actionable in order to generate positive expected returns by moving your funds along the yield curve. If it were that easy, every bond portfolio manager would be doing it. In order to make money, you have to express a view on interest rates that’s different from market expectations, AND you have to be correct about your expressed view. So no, retail investors should not be doing this - if they do it they may get lucky, but they’re not being smart.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Taylor Larimore » Mon Aug 06, 2018 8:11 pm

Counterpoint:

Excellent post.

Thank you and best wishes.
Taylor
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by goodenyou » Mon Aug 06, 2018 9:07 pm

Does the interest rate spreads between a near risk-free investment option of CDs or money market and bonds ever enter into the decision? What is the sweet spot between yield spread and duration risk? Is their any? Do you just buy intermediate term bonds and ignore all else?
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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by bgyt » Mon Aug 06, 2018 9:32 pm

So I deposited $25K in Vanguard this week which would typically go to my Bond allocation.

Are you saying it was a mistake to put it in VMMXX @ 2.06% vs. VBTLX?

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by vineviz » Mon Aug 06, 2018 9:39 pm

bgyt wrote:
Mon Aug 06, 2018 9:32 pm
So I deposited $25K in Vanguard this week which would typically go to my Bond allocation.

Are you saying it was a mistake to put it in VMMXX @ 2.06% vs. VBTLX?
If you don't intend to spend any of that money in the next year or two, it shouldn't be in a money market fund.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Counterpoint » Tue Aug 07, 2018 11:50 am

bgyt wrote:
Mon Aug 06, 2018 9:32 pm
So I deposited $25K in Vanguard this week which would typically go to my Bond allocation.

Are you saying it was a mistake to put it in VMMXX @ 2.06% vs. VBTLX?
I would suggest looking at your bond allocation in a portfolio context. If it’s part of a standard stock/bond allocation, the bond portion of the portfolio has a large role to play in diversifying your risk. For instance if there is a financial scare or crisis that sinks the stock market, there’s a good chance that a flight to quality into US Treasuries will cause a bond portfolio to perform very well. But the rally in bonds depends on the portfolio having the longer duration (i.e. interest rate sensitivity) of a bond portfolio, which a MM portfolio will not have. Yes, a MM portfolio will not lose money as your stocks would, but it would also not gain as much as VBTLX which has an average duration of about 6 years.

Of course, you will have greater ongoing price volatility in VBTLX than in MM, as a result of the higher duration (and also because there is a credit spread element in VBTLX since it is about 1/3 in corporate bonds). But this is something you should have looked at when setting your overall AA (or if you didn’t, perhaps you should review it now). Again, do not look at the volatility of VBTLX vs MM in isolation - look at it in the context of your overall stock+bond AA. You’ll probably find that it is a stabilizer to your overall portfolio.

For more on staying the course with your bond allocation, see for example this Vanguard research piece: https://personal.vanguard.com/pdf/s807.pdf Although written in 2013 when rates were lower, I believe the overall lessons are still relevant to your situation.

In summary, if you reallocated money to MM from bonds in the context of a standard stocks/bonds allocation, you’ve probably reduced the diversification of your overall portfolio. And this is in addition to not getting an expected benefit from moving down the yield curve, as explained earlier. You’re not alone btw in thinking this way about the Fed and interest rates. One of my previous jobs was managing a multibillion dollar Treasury portfolio, and we had to keep explaining to our CEO and BoD why there were no “obvious” moves if we knew the Fed was going to increase rates.
Taylor Larimore wrote:
Mon Aug 06, 2018 8:11 pm
Counterpoint:

Excellent post.

Thank you and best wishes.
Taylor
Thank you for your kind words, Taylor. And many more thanks for your wisdom and contributions to the financial literacy of so many of us.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by bgyt » Tue Aug 07, 2018 12:09 pm

^
This is extremely helpful.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Counterpoint » Tue Aug 07, 2018 3:06 pm

vineviz wrote:
Mon Aug 06, 2018 9:39 pm
If you don't intend to spend any of that money in the next year or two, it shouldn't be in a money market fund.
I don’t think I’d agree with such a blanket statement.

In general, with other factors like credit and liquidity risk being equal, the advantage of investing in a bond fund compared to a MM fund (over the next 2-3 years say) is that you expect to earn a “term premium”. The term premium is the risk premium for the uncertainty that future rates may not evolve along the lines expected today; another way to think about it is that it is a risk premium for the price volatility of higher-duration securities.

Term premiums cannot be directly observed but must be estimated from data on short-term and long-term interest rates. The best known model for estimating term premiums is the ACM model by 3 economists from the NY Fed. According to this model, the term premium is currently negative all along the yield curve from years 1 through 10 (and it has been this way for a couple of years). So in other words, you would expect to earn less from a Treasury bond fund than by just rolling over a Treasury MM fund - and you would be taking more price risk. So (slightly) lower expected return and greater risk - not what you expect. If you’re interested, here’s another BH topic on this negative term premium and some articles on it: viewtopic.php?p=4056798#p4056798

The implication is that if you have an expense you’re saving for in a couple of years, say a down payment on a house, there may be little reason to move from a MM fund to a short-term bond fund, at least based on today’s estimated negative term premium.

Keep in mind that the analysis above only focuses on interest rate risk and the term premium. There could be other ways you could earn a premium over MM funds: if you’re willing to take credit risk (e.g. corporate bonds instead of top-quality securities), liquidity risk (long term bank CDs) or optionality/negative convexity risk (MBS). It also does not take into account the portfolio diversification benefit of holding longer-duration bonds together with equities (as mentioned in my earlier post) - in fact this is one of the hypotheses for why a negative term premium exists today.

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Re: Market Timing Bonds vs. Money Market with Rising Interest Rates

Post by Toons » Tue Aug 07, 2018 3:10 pm

If you think it is a Good Idea then do it.
I wouldn't make a decision on this matter as to what others would do,

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