Why didn't bond funds go down?

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sawhorse
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Why didn't bond funds go down?

Post by sawhorse » Mon Feb 01, 2016 1:42 pm

When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!

swl
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Re: Why didn't bond funds go down?

Post by swl » Mon Feb 01, 2016 1:49 pm

Bond funds went down last year in anticipation of rate increases. Looks like rate increases will go slower than previous expectations. Also flight to safety because crude / China.

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HomerJ
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Re: Why didn't bond funds go down?

Post by HomerJ » Mon Feb 01, 2016 2:09 pm

The Fed raised interest rates from 1% to 5% from 2004-2006.

Here's what bond funds did...

Image

The Fed raising rates, contrary to popular belief, doesn't always equal ALL interest rates going up, and doesn't always equal bond funds crashing and burning.

I hate pundits, talking about bond "crashes" and bond "massacres".

Image

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FelixTheCat
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Re: Why didn't bond funds go down?

Post by FelixTheCat » Mon Feb 01, 2016 2:10 pm

HomerJ wrote:The Fed raised interest rates from 1% to 5% from 2004-2006.

Here's what bond funds did...

Image

The Fed raising rates, contrary to popular belief, doesn't always equal ALL interest rates going up, and doesn't always equal bond funds crashing and burning.

I hate pundits, talking about bond "crashes" and bond "massacres".

Image
Thanks for the graphs. Very informative.
Felix is a wonderful, wonderful cat.

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telemark
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Re: Why didn't bond funds go down?

Post by telemark » Mon Feb 01, 2016 2:26 pm

Everything else being equal, bonds will go down when interest rates go up, but everything else is never equal. For one thing, stocks are down and some of that is probably people moving into bonds.

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ogd
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Re: Why didn't bond funds go down?

Post by ogd » Mon Feb 01, 2016 2:44 pm

sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!
Interest rates (as seen on TV, meaning Fed overnight) and bond yields (longer) are not the same thing. The latter anticipate the former, which is why it's very hard for us to move ahead of such telegraphed moves. That's really all there is to it.

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ogd
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Re: Why didn't bond funds go down?

Post by ogd » Mon Feb 01, 2016 3:06 pm

ogd wrote:
sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!
Interest rates (as seen on TV, meaning Fed overnight) and bond yields (longer) are not the same thing. The latter anticipate the former, which is why it's very hard for us to move ahead of such telegraphed moves. That's really all there is to it.
To elaborate a little more, your question directly translates to "why didn't longer yields go up when short rates went up?". This exposes the difference and instead makes you wonder "why would they, at that specific point in time?"

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nisiprius
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Re: Why didn't bond funds go down?

Post by nisiprius » Mon Feb 01, 2016 3:12 pm

I mean this very seriously, no exaggeration: I don't think the dependability of predictions and analysis about investments isn't any higher than those for sports.

Just one clarification: the charts HomerJ showed show total return. They are growth charts which include all of the interest paid out by bonds in the fund. I think that's absolutely the right way to look at it, but we should be clear that that's what we're looking at. The value of an individual bond is normally about the same at the issue and at maturity, and the growth comes from the regular interest it pays out in between.
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Phineas J. Whoopee
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Re: Why didn't bond funds go down?

Post by Phineas J. Whoopee » Mon Feb 01, 2016 3:13 pm

sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!
I agree that bond behavior can be complex and confusing, but this particular time I think you have, probably from everybody constantly shouting it at you, an overly simplified picture of interest rates and of bond prices. It's not your fault. Anybody would get that impression.

The Fed only sets extremely short term rates, and they don't apply to you and me. They apply to banks lending to each other overnight, from the ones who ended the business day with more money than regulations require, to the ones who ended up with less. That's the Federal Funds Rate, Fed Funds Rate, or FFR. It also sets the Discount Rate, at a higher level. It's what banks with too little in reserves pay the Fed directly if they're in so much trouble no other bank will trust them, not even overnight. That part is the Fed acting in its capacity as lender of last resort.

Bond rates are set by auction. The Fed has influence, but doesn't control them.

Bond yields, which a lot of people call interest but it turns out that's ambiguous, depend on several things, but top of the list are two:
A) How long the bond has left until maturity, with longer maturities almost always having higher yields, factor B being equal; and
B) How likely the borrower is to pay back the loan.

Vanguard's Total Bond Market Index Fund, VBMFX, holds many maturities, ranging from less than one year, to over thirty. Its average maturity is eight years. That's well over two thousand overnights.

The fund is investment grade, which means it only holds bonds judged by ratings agencies, the market, and Vanguard itself, as being pretty likely to pay out, but pretty likely isn't the same as never possibly could default under any circumstances.

The advantage of saying the Fed controls interest rates, and bonds go up and down in the opposite direction, is it gives a very simple view of the world. The disadvantage is that view fails to predict what happens in the world. It isn't even a matter of theory vs. practice, because the simplified view doesn't even qualify as theory. It's more of a soundbite, and the press is capable of saying something falling above the soundbite and short of this is a linear approximation of a nonlinear function.

Hope that's helpful in some way.

PJW
Last edited by Phineas J. Whoopee on Mon Feb 01, 2016 7:18 pm, edited 1 time in total.

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Toons
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Re: Why didn't bond funds go down?

Post by Toons » Mon Feb 01, 2016 3:15 pm

Bonds didn't go down?
Thanks
Good to know.
It just reaffirms proper asset allocation to me. :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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dm200
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Re: Why didn't bond funds go down?

Post by dm200 » Mon Feb 01, 2016 3:28 pm

While brokered CD rates do not track precisely with similar term bonds, they do change with bond rates in a similar way.

So, for example, on November 19, 2015 - the Vanguard available 3 month brokered CD paid 0.35%. Those short term rates have gone up and today, for example, a 3 month brokered CD was available at 0.50%. The five year brokered CD rate on December 18, 2015 was 2.35% and today the available rate is 2.00%. Longer term rates have gone down, not up as have short term rates.

jalbert
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Re: Why didn't bond funds go down?

Post by jalbert » Mon Feb 01, 2016 3:38 pm

sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!
Interest rates have a term structure, which means that there are different rates for different maturity terms. Collectively, all of the rates are also referred to as the yield curve, referring to a graph with term to maturity on the x-axis and interest rate or yield on the y-axis.

The closer you are to the short end of the curve, the more sensitive the rate is to the Fed activities that are embodied in what is reported as the fed raising an interest rate (which is in fact just a targeted side effect of what the fed actually does).

The further out on the curve you are, the more sensitive the rate is to changes in macroeconomic outlook, incoming inflation data, etc. Medium and long rates will usually decline, for instance, if the market is pricing in an increase in the perceived chance of a recession.

If the Fed raises rates in response to improving economic conditions, it is generally the improving economic conditions that will drive medium and long rates higher. The fed rate increase by itself, by virtue of having some dampening affect on economic activity, mostly applies some downward pressure on medium and long rates.

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saltycaper
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Re: Why didn't bond funds go down?

Post by saltycaper » Mon Feb 01, 2016 3:44 pm

To add to HomerJ's dislike of the "bubble" and "crash" terminology, if you believe there exists a natural rate of interest given economic conditions, then interest rates can be very low without that being in itself any indication of bubble. The real question is, are rates higher or lower than they should be? (Obviously a difficult question to answer.) But I never read this in the popular financial media. It's always, "Rates are so low (prices are so high), they must go up (prices must come down)." This is no more accurate than looking at the price of stock and saying, "It fell from $100 to $10, so it must be 'cheap'", which is of course not necessarily correct. I think this is relevant to your question about why bond funds didn't go down because, as others have pointed out, the behavior of bonds and bond funds is often inaccurately described due to faulty assumptions and mischaracterizations. Not only does the media often get the math wrong, they get the fundamentals wrong too.
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patrick013
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Re: Why didn't bond funds go down?

Post by patrick013 » Mon Feb 01, 2016 4:04 pm

I think it's safe to say that when the Fed raises the Fed rate it
wants or would like the rate increase to filter upstream to all
terms according to historical and average spreads.

Explanatory reasons why this does or does not happen are very
pragmatically described, to me, as supply/demand observations.

Right now, with or without rate changes, I think a pretty good
Flight to Quality is occurring. So, to me, that adequately identifies
the reason for TRSY and other bond price movements lately.

Govt prices up, Corp prices down, Muni prices(esp. transportation) up.

If there is ever going to be an equilibrium interest rate it will have
to be based on a higher Fed rate held steady for many years. :beer
age in bonds, buy-and-hold, 10 year business cycle

livesoft
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Re: Why didn't bond funds go down?

Post by livesoft » Mon Feb 01, 2016 4:18 pm

Clearly, the movements of interest rates have already been priced in to bond funds for some time. The "market" somehow figured it out. :)
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biscuits222
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Re: Why didn't bond funds go down?

Post by biscuits222 » Mon Feb 01, 2016 7:15 pm

January was a month of heavy stock-market selling and Treasury bond prices often do very well during a stock decline (perhaps because the money from heavy selling literally goes into Treasury bonds). iShares Long-term Treasury ETF was up 5% in January while Vanguard Total Stock Market was down around the same, a beautiful symmetrical ballet that has often repeated itself in the last ten years:

https://www.google.com/finance?q=NYSEARCA%3ATLT

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David Jay
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Re: Why didn't bond funds go down?

Post by David Jay » Mon Feb 01, 2016 7:55 pm

Google "flight to safety", perhaps add in the term "stocks" or "stock market".

Bonds also go up when people are anticipating that the stock market will go down. Behavioral Finance.
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nedsaid
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Re: Why didn't bond funds go down?

Post by nedsaid » Mon Feb 01, 2016 9:18 pm

sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!
The simple answer is that interest rates went down and not up with the sole exception of the very short term rates which are set by the Fed. The increase in the short term rates were only 0.25%. Not much.
A fool and his money are good for business.

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Bustoff
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Re: Why didn't bond funds go down?

Post by Bustoff » Wed Feb 03, 2016 12:18 pm

Some rates are going negative. (eg. BOJ, Germany)
Rates can't go negative unless someone is willing to buy them.
Other than someone betting rates will fall even farther, who would buy negative yield bonds?

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ogd
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Re: Why didn't bond funds go down?

Post by ogd » Wed Feb 03, 2016 12:35 pm

Bustoff wrote:Some rates are going negative. (eg. BOJ, Germany)
Rates can't go negative unless someone is willing to buy them.
Other than someone betting rates will fall even farther, who would buy negative yield bonds?
Someone who needs to store 100 million Euros for next quarter's business spending. They have few other options.

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Re: Why didn't bond funds go down?

Post by Call_Me_Op » Wed Feb 03, 2016 12:45 pm

sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down.
Incorrect. Where did you hear that?
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patrick013
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Re: Why didn't bond funds go down?

Post by patrick013 » Wed Feb 03, 2016 2:31 pm

jalbert wrote:
sawhorse wrote:When the Fed raises interest rates, bond funds are supposed to go down. Yet Total Bond Market is up over 1% already this year. Can someone explain this? Bonds are so confusing!

The further out on the curve you are, the more sensitive the rate is to changes in macroeconomic outlook, incoming inflation data, etc. Medium and long rates will usually decline, for instance, if the market is pricing in an increase in the perceived chance of a recession.
And that happens roughly 10% of the time, if one added all the corrections
and business cycle downturns and their affect on the yield curve lowering
or becoming flatter as growth and business activity declines.
If the Fed raises rates in response to improving economic conditions, it is generally the improving economic conditions that will drive medium and long rates higher. The fed rate increase by itself, by virtue of having some dampening affect on economic activity, mostly applies some downward pressure on medium and long rates.
Well 90% of the time we do have a profitable economy waiting for the
10 year business cycle to show the slow periods. Liquidity preference
is very active in good economic periods. I think interest rate rises will
help the economy as overproduction capacity is already tangibly present
from a business perspective. Just need some disposable income to turn
the engines up a bit. Otherwise, liquidity preference is being trumped
quite a bit lately by flight to quality reducing high quality bond yields.
Maybe even from overseas purchasers, don't know ? A different way of
saying the same thing.
age in bonds, buy-and-hold, 10 year business cycle

kenner
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Re: Why didn't bond funds go down?

Post by kenner » Wed Feb 03, 2016 2:53 pm

Bond funds didn't automatically go down in net asset value because the Fed only sets one interest rate - that interest rate being the Fed funds rate, the rate that banks charge one another for overnight loans (pretty short-term, wouldn't you say?). The Fed can influence global market interest rates, but it does not dictate them.

The overall market determines all other interest rates, not the Fed. And the overall market has dozens of factors that determine interest rate expectations across the broad spectrum of debt securities, including maturities as long as 30 years, anticipated creditworthiness of thousands of issuers of debt across the globe, etc.

Anyone who thinks that a one-quarter percent increase in the Fed funds rate means that every bond and bond fund will automatically and instantly fall in value in proportion to the Fed funds increase needs to do a bit more studying about the economic and financial worlds.

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Re: Why didn't bond funds go down?

Post by saurabh » Wed Feb 03, 2016 4:37 pm

HomerJ wrote:The Fed raised interest rates from 1% to 5% from 2004-2006.

Here's what bond funds did...
From June 2003 to June 2006 the price of the Vanguard Total Bond Market Fund (VBMFX) fell 9.4% from peak to trough over a 3-year period ($10.68 on 6/13/2003 to $9.68 on 6/28/2006). The reason the chart you show looks more reassuring is because the yield on the fund was high (about 5%) and it assumed that interest payments are reinvested. The current yield is about 2.2%, so for the same interest rate spike, the decline would be higher. The difference in the yields is 3%, which over a 3 year period will be approximately 10% to total returns. Now mind you, I don't think we have to realistically worry about the yield on VBMFX ever rising to 5% over the next few years. We seem to be in a period of secular low interest rates.

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Re: Why didn't bond funds go down?

Post by SeeMoe » Wed Feb 03, 2016 7:42 pm

All I know is that I sure Am glad that I didn't listen to the " talking heads" telling us to get out of Dodge (aka bonds) STAT as their NAV was bound to plummet as interest rates begin to rise ! Of course stocks were doing good then too as I Recall, but my VPAS advisor said to " stay the course" with my retiree folio of 45/55 . It's about 41/59 now .
SeeMoe.. :mrgreen:
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saurabh
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Re: Why didn't bond funds go down?

Post by saurabh » Wed Feb 03, 2016 8:48 pm

SeeMoe wrote:All I know is that I sure Am glad that I didn't listen to the " talking heads" telling us to get out of Dodge (aka bonds) STAT as their NAV was bound to plummet as interest rates begin to rise ! Of course stocks were doing good then too as I Recall, but my VPAS advisor said to " stay the course" with my retiree folio of 45/55 . It's about 41/59 now .
SeeMoe.. :mrgreen:
Fed was increasing short-term rates, long-term rates need not have gone up by same amount. Also market participants think that the Fed isn't really going to follow through. Returns on bonds have not been great for the past 3 years. At least I don't consider a 2% annualized return to be great.

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Phineas J. Whoopee
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Re: Why didn't bond funds go down?

Post by Phineas J. Whoopee » Thu Feb 04, 2016 10:51 pm

ogd wrote:...
Someone who needs to store 100 million Euros for next quarter's business spending. They have few other options.
:!:

Imagine a trans-national corporation, whose continued existence doesn't depend on any UN-member state's particular set of laws, like, for example, Apple, trying to meet payroll every two weeks out of $250,000 FDIC-insured savings accounts.

PJW

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patrick013
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Re: Why didn't bond funds go down?

Post by patrick013 » Thu Feb 04, 2016 11:25 pm

Well all we can do is see what happens.

On one hand potential rate increases lowering bond prices
albeit with imperfect information, and on the other hand a
flight to quality increasing bond prices. End result=no effect
or some variable effect like expect the unexpected or enjoy
the volatility 'cause that's all you're going to get. Well
it's a bull taking some volatility that's for sure. :D
age in bonds, buy-and-hold, 10 year business cycle

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