Fed Rate [may go] to 3% - [investing consequences?]

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by boglephreak » Thu Jan 19, 2017 4:54 pm

nisiprius wrote:snip
interesting graphs. now i know why interest on my undergrad loans (1998-2002) were so much higher than law school (2002-2005), and interest on my condo (2006) was insane.

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Kevin M
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Kevin M » Thu Jan 19, 2017 5:35 pm

nisiprius wrote:
Kevin M. wrote:This particular period was and remains a curiosity in that it defied expectations at the time.
Funny. This is the second time in two days that someone has messed up the quotes and attributed something to me that I did not say. Here it is with proper quoting:
VaR wrote:
Kevin M wrote:
btenny wrote:Previous multiple rate raises in a single year have caused the economy to go down. Plus this will cause bonds to go down for sure.
Really? For sure?
<snip--removed chart to save space>
Note that during this period of federal funds rate (FFR) increases, the 10-year yield decreased (which of course means the price of 10-year Treasuries increased). Of course the 1-month yield increased along with the FFR.
<snip>
This particular period was and remains a curiosity in that it defied expectations at the time.
So it was VaR that said this, not me.

I've said many times that the FFR is not what drives longer-term bond yields, it's the economy and expectations about the economy that drives them. The Fed responds to the economy by adjusting the FFR. Sometimes longer-term bond yields and the Fed respond to the economy similarly, sometimes they don't. There are many examples, not just the period I showed the chart for.

The period since 2009 is another example, with the FFR close to 0%, but the 10-year Treasury moving all over the place, from as high as about 4% to as low as about 1.5%:

Image

Also as I've said before, over longer time periods, yields for all maturities will tend to move up and down together (unless there are specific interest rate controls in place), since all bond yields will generally respond similarly to a stronger or weaker economy, and to higher or lower inflation. But there can be huge disconnects over shorter time periods. We see all of this if we look at a longer time period for the FFR and 10-year Treasury yield:

Image

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by nisiprius » Thu Jan 19, 2017 5:59 pm

Apologies, Kevin, I've corrected the attribution in my posting.
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by patrick013 » Thu Jan 19, 2017 6:25 pm

Image

Well now that we're supposed to be starting a secular trend of
rising rates (left side of graph) perhaps we'll never see TRSY's
at less than 3% again. When predictions (forewarnings) become
reality or "perfect information" as information has become in the
past that will be nice.
age in bonds, buy-and-hold, 10 year business cycle

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Kevin M
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Kevin M » Thu Jan 19, 2017 6:38 pm

btenny wrote:How do you guys/gals do CDs for a IRA account? Do you just set up a second IRA account at some place like the Navy Federal Credit Union and then transfer some IRA money to that account.
I generally go for the highest rate with the lowest early withdrawal penalty (EWP), whether it's at a bank or credit union I already use or not. Of course FDIC/NCUA deposit insurance limits may require using a new bank or CU. If I already have an IRA at the bank or CU, I just open another IRA CD and fill out the IRA transfer form to transfer money into it. Sometimes you have to transfer to a savings or share account first, but either way, it's easy.

For a bank, I open an IRA CD (may not have to open any other accounts) then do the transfer as above. For CUs, I first become a member, then open an IRA, then do the IRA transfer and open an IRA CD.
Then what do you do in 2-3 years when the CD expires?

I almost never buy CDs with less than five years to maturity, and sometimes six or seven, so it's more than 2-3 years for me. If I like the new CD rates and EWP at the current bank or CU, I just let the CD roll over to a new CD of same maturity. If I don't, I transfer it to a bank or CU where I do like the rates and EWP. I have done this two ways. One is to have maturing CD proceeds put into an IRA savings account, then transfer from there. The other is to indicate on the transfer form to have the proceeds taken from the CD at maturity.

I used to have a bunch of IRA CDs at Ally Bank, but due to uncompetitive rates in recent years, I transferred proceeds of all but one matured IRA CD to credit unions offering much better deals (e.g., 7-year CD at 3%, 5-year CD at 2.7%). I let one roll over at Ally because it was small and the rate was good enough for that small amount (2% for 5-year). Similarly, I transferred proceeds from a matured PenFed CD to another credit union for a much better deal, but now PenFed CDs are again competitive, but EWP is steep.
Moving stuff around and setting up extra accounts seems a lot of trouble for a little extra money.
For many people I'm sure this is true, but not for me. My average yield premium over Treasuries of same maturities has been more than 100 basis points for CDs bought over last 6+ years. On $1M, that's an extra $10K in one year, and more than $50K in five years. That's for basically same credit risk, and less term risk due to early withdrawal option. Well worth it to me.
And other data that Soft pointed out is the 10 year Treasury rate is still only 2.5%. Way below where it has been for many decades previously. So it is likely to go up some more and soon.
I have zero confidence in my ability to predict interest rates, and zero confidence in anyone else's ability to do so. Still, if I can buy a fixed-income security that pays me 100 basis points more than a Treasury of same maturity, and also limits my downside to say 1% on a 2% CD, or 1.5% on a 3% CD in the event of a big increase in yields (vs. 5% or more on a Treasury of same maturity), in which case I can do an early withdrawal and reinvest at the higher rate, then I'm going to win either way vs. holding a Treasury of same maturity.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by RAchip » Thu Jan 19, 2017 9:43 pm

After the Federal Reserve increased the target fed funds rate in Dec. 2016, all of the nation's biggest banks immediately raised their prime rate. The fed funds rate doesn't just have an impact on the price that banks pay to borrow money from each other. It also directly impacts the interest rate on your mortgage, home equity loan, or car loan, as well as the interest rate that businesses pay to borrow money in order to expand.

If the FFR goes up to 3% (meaning banks have to pay 3% to borrow from each other on overnight loans), I expect the government is going to have to pay A LOT more than that to borrow from the public for 10 years.

I think people are understimating how bad things could get for bonds over the next 4-8 years.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by kenner » Thu Jan 19, 2017 10:10 pm

RAchip wrote: If the FFR goes up to 3% (meaning banks have to pay 3% to borrow from each other on overnight loans), I expect the government is going to have to pay A LOT more than that to borrow from the public for 10 years.

I think people are understimating how bad things could get for bonds over the next 4-8 years.
Understood. So, given the status and forecast for the U. S. and global economies, what is your prediction for the magnitude and velocity of increases in the Fed funds rate?

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by VaR » Thu Jan 19, 2017 11:26 pm

nisiprius wrote:
VaR wrote:This particular period was and remains a curiosity in that it defied expectations at the time.
If I may twist things a bit, it is not at all a "curiosity" when the bond market "defies expectations at the time." For example, in 2014 a total of 67 out of 67 economists surveyed by Bloomberg predicted the 10-year Treasury rate would rise over the next six months.

It fell.
You misunderstand what I mean by "defied expectations". I don't mean that it defied a prediction that the fed would increase rates and that that would cause an increase in rates. I mean that in 2004, that the expectation was that higher short term rates would, over time, lead to higher long term rates. It was the expectation that this relationship would hold that was defied.

I can find the reasoning for the polled economists to predict that rates would go up in 2014 - was it that they thought that the Fed would start raising the fed funds rate? Was it that the Fed announced that it was tapering off quantitative easing? Was it that they predicted that inflation would pick up? Was it that they predicted that we would reach full employment? All of the above?

At any rate, their predictions of what the economy and the Fed would do were incorrect. The Fed did taper off QE in 2014. They only purchased an additional $400 billion in Treasury and mortgage securities in 2014 - peaking at $2.46 trillion in Treasury securities and $1.74 trillion in mortgage securities by the end of 2014. And it turned out that "tapering off" quantitative easing did not mean selling anything. They still hold this amount of bonds.

At any rate, this diversionary discussion takes us off of my core point: that the Fed in 2017 intends to slow the economy and/or prevent an asset bubble from forming by using the tools at its disposal - first raising short term rates and if that doesn't work by doing what it can to raise long term rates. Who knows, it may even choose to actually stop replacing maturing bonds in its QE portfolio.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by VaR » Thu Jan 19, 2017 11:41 pm

kenner wrote:
RAchip wrote: If the FFR goes up to 3% (meaning banks have to pay 3% to borrow from each other on overnight loans), I expect the government is going to have to pay A LOT more than that to borrow from the public for 10 years.

I think people are understimating how bad things could get for bonds over the next 4-8 years.
Understood. So, given the status and forecast for the U. S. and global economies, what is your prediction for the magnitude and velocity of increases in the Fed funds rate?
The missing factor is the strength of the U.S. economy. The Fed reacts to unemployment statistics and inflation statistics to carry out its two missions of controlling inflation and, secondarily, maintaining full employment. Predicting the Fed funds rate is tantamount to predicting inflation and unemployment, or semi-equivalently, inflation and the strength of the economy. That said, the Fed is currently biased to raise short term rates as long as this doesn't cause an economic slowdown and unemployment. This is because ideally, they need the Fed funds rate to be 2% in order to have breathing room to drop it if there is a recession in the future. 3% would be even better.

As a Boglehead, I want to say that all this speculation is idle in that it doesn't change my IPS, my stock/bond allocation, my international/domestic allocation, or even my bond term allocation. For me, intermediate bonds was fine 20 years ago, was fine in 2008, was fine last year, and is fine for me now. Total bond market would also have been fine.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Bfwolf » Fri Jan 20, 2017 12:17 am

OP, you've said a couple of times that longer-term interest rates are likely to increase in the next few years. This statement is the core of your confusion.

All publicly available information, including what JY has said the Fed would like to do, is incorporated into longer-term interest rates, which are set by the market and not the Fed. Here's current US treasury interest rates:

3 year: 1.53%
5 year: 1.97%
7 year: 2.28%
10 year: 2.47%
20 year: 2.77%
30 year: 3.04%

The rates increase with duration, which is probably somewhat attributable to the expectation of interest rates going up modestly over time. So that's already baked in. If rates go up higher than what the market has built in, it will hurt bond prices and vice versa. If you believe in the wisdom of markets, you believe that rates are just as likely to go lower than expectations as they are to go higher.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by btenny » Fri Jan 20, 2017 2:57 pm

Wolf. I know the FFR is set exactly by JY. I also get you point about longer rates being set by the market. But when the 10 year Treasury rates went up a ton in the 4th quarter was JY "managing" the longer rates as well using her QE assets? We all know they hold a ton of them due to QE. Is there some place you can look at government data and see what they are doing regarding QE assets? Do they tell us if they sell or buy? Or at least that is how I understood what they can do. Correct?

Good Luck.

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Re: Fed Rate to 3%

Post by Kevin M » Fri Jan 20, 2017 3:31 pm

VaR wrote:
Kevin M wrote: Note that during this period of federal funds rate (FFR) increases, the 10-year yield decreased (which of course means the price of 10-year Treasuries increased). Of course the 1-month yield increased along with the FFR.

Kevin
This particular period was and remains a curiosity in that it defied expectations at the time. Long term rates are not correlated 1.0 with short term rates, but during this time people did expect long term rates to go up.
Perhaps, but it's easy to find other periods when the FFR went up and the 10-year Treasury yield went down, or vice versa, or periods when the 10-year yield just didn't seem to respond much to changes in the FFR.

And saying that the correlation between the FFR and long term rates is not 1.0 is a huge understatement of the point I've been making (here and in other posts), which is that the FFR does not drive long term rates, nor is the relationship between them at all consistent.
RAchip wrote: If the FFR goes up to 3% (meaning banks have to pay 3% to borrow from each other on overnight loans), I expect the government is going to have to pay A LOT more than that to borrow from the public for 10 years.
Another way of saying this is that you expect the spread between 10-year Treasuries and the FFR to be large and positive. For example, if this spread remained where it is now, at about 2 percentage points, you'd expect the 10-year Treasury yield to be about 5% if the FFR were about 3%.

The thing is that the spread between 10-year Treasuries and the FFR is very volatile; it is not consistently large and positive, although it is positive much more often than it is negative. Historically it has generally ranged between 0 and 4 percentage points, but there have been periods when the FFR was higher than the 10-year Treasury yield. The FFR was more than 9 percentage points higher than the 10-year Treasury yield at the end of 1980.

All of the points I'm making above can be seen by careful examination of the chart below, which shows the year-end values of the FFR and 10-year Treasury yield, along with the spread between them (10-year minus FFR).

Image

First note the volatility of the dashed gray line (right vertical scale), which shows the spread (10yr minus FFR). If the relationship were consistent, with a positive spread, we'd see something more like a flat line at some positive value, but this obviously is not what we see. This is where we see the spread typically cycling between about 0 and 4 percentage points, but sometimes going negative, and way negative at the end of 1980 and 1986.

Looking at where the spread approaches or drops below 0 percentage points is an easy way to find periods when the 10-year yield (solid blue line) either moved in the opposite direction of or did not respond much to (e.g., moved up or down a lot less) the FFR (solid red line).

For example, from the end of 1971 to the end of 1973 the FFR increased by almost 7 percentage points, from 3.00% to 9.83%, while the 10-year yield increased by less then 1 pp, from 5.93% to 6.74%. Then over the next year, the FFR decreased by almost 6 pp, to 3.87%, while the 10-year yield continued to increase to 7.43%.

Or look at the end of 1984 to the end of 1986, when the FFR increased from 8.74% to 14.35%, while the 10-year yield decreased from 11.50% to 7.11%. The end of 1992 to the end of 1996 is another period when these rates moved in opposite directions.

So financial history provides plenty of examples showing that the FFR does not drive longer-term bond yields.
RAchip wrote:I think people are understimating how bad things could get for bonds over the next 4-8 years.
Perhaps, but that's not the point some of us are discussing in this thread, which is that an expected increase in the FFR over the next couple of years, in itself, is not cause for this particular concern--at least not based on financial history. There are two main components that could cause negative real bond returns in coming years: an increase in real yields and an increase in the inflation rate (nominal yield being essentially real yield plus expected inflation). Of course both of these also would almost certainly result in a higher FFR, but that doesn't mean that the latter is causing bond losses.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Engineer250 » Fri Jan 20, 2017 4:03 pm

Dumb bond question...

Is it ever possible for yields and bond prices to travel in the same direction? Is there any scenario that bond prices and bond yields would both go simultaneously down or up? I know that's not "normal" I just wonder if there's a scenario that could cause it.
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by patrick013 » Fri Jan 20, 2017 4:33 pm

Image

All that volatility and not a single clue what caused it. Here's a graph
showing the really flat state of the TRSY bonds between 10 and 30 years.
Noting that the FFR isn't the only tool in the toolbox I suspect some
unannounced quantitative easing is occurring as higher rates are anticipated
with every Fed announcement, so economic projections should lead to
slightly higher spreads in that range. Unannounced quantitative easing
goes on quite regularly so I don't even discern why they'd announce it.
Alternatively they could do reverse quantitative easing and cause and control
and actually set higher rates in that range by selling a few billion in bonds
in the secondary market from one of their trust funds every once in awhile at
the higher rate. But they do like it when that range is a little low rate wise.

Don't really have any hard data for the above just some trust fund balances
in Barron's...and the fact that buying and selling to alter the TRSY market
somewhat is in the Fed's toolkit. I don't know why anyone would want a 30
year bond that only pays 3% anyway.

FFR at 3% by 2019 ? Good year to have some CD's mature. What a plan. :)
Last edited by patrick013 on Sat Jan 28, 2017 3:05 pm, edited 1 time in total.
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Phineas J. Whoopee » Fri Jan 20, 2017 4:40 pm

Engineer250 wrote:...
Is it ever possible for yields and bond prices to travel in the same direction? Is there any scenario that bond prices and bond yields would both go simultaneously down or up? I know that's not "normal" I just wonder if there's a scenario that could cause it.
Yields and prices are locked in a mathematical relationship. Saying one went down means precisely the same as saying the other went up. You can solve for either.

Here's the Yield to Maturity, YTM, math with a calculator.

PJW

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Kevin M » Fri Jan 20, 2017 4:44 pm

btenny wrote:Wolf. I know the FFR is set exactly by JY. I also get you point about longer rates being set by the market. But when the 10 year Treasury rates went up a ton in the 4th quarter was JY "managing" the longer rates as well using her QE assets? We all know they hold a ton of them due to QE. Is there some place you can look at government data and see what they are doing regarding QE assets? Do they tell us if they sell or buy? Or at least that is how I understood what they can do. Correct?

Good Luck.
I figured FRED should have data to answer questions like this. First I found this:

Image

Note that this is for all maturities, not just longer-term Treasuries. Looking a bit more, I found the data series for long-term Treasuries held by the Fed, so added this to the chart:

Image

This shows us that the Fed bought lots of Treasuries from 2009 through 2014, and has been holding kind of steady since then, but with some decrease in its holding of long-term Treasuries since 2014.

Buying increases demand and reduces supply, which should drive prices up (and yields down). Of course in general we've seen historically low yields during this period, but how much has the Fed program affected this for longer-term Treasuries? Let's look at just the long-term Fed holdings along with the 10-year yield:

Image

I don't know about you, but I don't see a huge correlation here. While the Fed was increasing its long-term holdings, the 10-year yield went up, and down, and up, and down, and now is at about the same level it was at the end of 2008.

Let's zoom into the period you asked about, Q4 of 2016:

Image

I still don't see a direct relationship here. The Fed increased their long-term holdings the week ending Nov 16 and the 10-year yield increased, then the Fed decreased their holdings the following week and the 10-year yield increased more.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Quark » Fri Jan 20, 2017 4:49 pm

Kevin M wrote:...I still don't see a direct relationship here. The Fed increased their long-term holdings the week ending Nov 16 and the 10-year yield increased, then the Fed decreased their holdings the following week and the 10-year yield increased more.

Kevin
The last time I looked, Fed purchases were a very small part of total volume and had a very small effect on pricing.

The Fed appears to influence rates much more through communicating its desires than some mechanical tie between its actions (moving FFR, market purchases, IOR policy) and rates. Its actions, of course, function as a signal. The overall economy is important. Causality flows back and forth between the Fed and the market.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Kevin M » Fri Jan 20, 2017 6:36 pm

Phineas J. Whoopee wrote:
Engineer250 wrote:...
Is it ever possible for yields and bond prices to travel in the same direction? Is there any scenario that bond prices and bond yields would both go simultaneously down or up? I know that's not "normal" I just wonder if there's a scenario that could cause it.
Yields and prices are locked in a mathematical relationship. Saying one went down means precisely the same as saying the other went up. You can solve for either.

Here's the Yield to Maturity, YTM, math with a calculator.

PJW
Of course what PJW says is true for any particular bond, but the answer to the general question about bond yields and prices moving in opposite directions is more nuanced. I've recently been publishing a series of blog posts on this very topic. Here is a link to Part 1 (so far there are five parts, and I'm working on Part 6): Bond Basics: Part 1. The BH Wiki also has some good articles on bonds that cover this.

The bottom line is although bond yield and price are two ways of expressing the value of a bond, are precisely linked by a mathematical formula, and always move in opposite directions, that doesn't mean that the yield on one bond can't go up while the price on another bond also goes up. We've been discussing something very similar to this in this thread, seeing that the very short-term federal funds rate (along with very short-term Treasury yields) can move one way while yields on longer-term bonds move the other way.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Phineas J. Whoopee » Fri Jan 20, 2017 7:13 pm

And what Kevin says is true.

I had interpreted Engineer250's reference to yields, plural, and prices, also plural, to be more general. Of course changes in term risk will not be expressed in parallel across the yield curve, but we don't know future non-parallel-osity (that's pretty awkward; should it be non-Euclidean yield curve geometry? chaotic fluctuations? fractal characteristics?). I don't even want to try to decline antiinversionism.

Fixed income carries credit risk, too, which I didn't address but is very important.

Engineer250: if I misinterpreted your question as being in general, while you were asking about a specific shorter-term bond from one issuer, compared to a longer-term one from another issuer, then I failed to answer in detail, and you should listen to Kevin but not to me.

You should listen to Kevin in any case.

PJW

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Northern Flicker » Fri Jan 20, 2017 9:04 pm

btenny wrote:Previous multiple rate raises in a single year have caused the economy to go down. Plus this will cause bonds to go down for sure.
The bond market usually behaves in a manner where those two sentences are contradictory. Bonds usually rally in response to economic weakness.

Fed rate increases are a tap to the brakes on the economy, which exerts upward pressure on bond prices. The strength in the economy that makes the Fed increases possible is what has downward pressure on bond prices. Nobody knows which will win out or when the economy will turn, and the Fed will start lowering rates.
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by bikenfool » Sat Jan 21, 2017 11:12 am

patrick013 wrote:Image

Well now that we're supposed to be starting a secular trend of
rising rates (left side of graph) perhaps we'll never see TRSY's
at less than 3% again. When predictions (forewarnings) become
reality or "perfect information" as information has become in the
past that will be nice.
I'm having a hard time believing 2.2% total return on the left side of the chart. A simple example: If I buy a bond in 1950 and hold it until maturity I'll make a little more than 2%. In 1960 my coupon is about 4%, 1970 about 6%. So I would expect total return around 4% in this period. Perhaps the total return quoted is real and the coupon is nominal?

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Re: Fed Rate to 3%

Post by unclescrooge » Sat Jan 21, 2017 11:17 am

Tanelorn wrote: She doesn't need to predict the future - she can move the whole market just by giving a speech.
My finance professor once joked the official term is "jaw boning".

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Kevin M » Sat Jan 21, 2017 2:36 pm

bikenfool wrote:
patrick013 wrote:Image
<snip>
I'm having a hard time believing 2.2% total return on the left side of the chart. A simple example: If I buy a bond in 1950 and hold it until maturity I'll make a little more than 2%. In 1960 my coupon is about 4%, 1970 about 6%. So I would expect total return around 4% in this period. Perhaps the total return quoted is real and the coupon is nominal?
Using data from the Simba backtest spreadsheet, I get these results for short-term Treasuries (STT), intermediate-term Treasuries (ITT), and long-term Treasuries (LTT)

1950-1980 nominal (inclusive, so 31 years):
STT 4.2%
ITT 3.3%
LTT 1.6%

I'd expect the 10-year Treasury return to be between ITT and LTT, so ballpark 2% seems reasonable. Note that this probably is not for holding 10-year Treasuries to maturity, but for rolling them annually, so there's a capital return component (probably negative in this case) unlike for a bond held to maturity.

Real returns were negative for this period:

1950-1980 real
STT -0.09%
ITT -0.95%
LTT -2.5%

And for the later period:

1980-2010 nominal (inclusive, so 31 years):
STT 7.4%
ITT 8.5%
LTT 9.3%

So 11% seems a bit high, but clearly bond returns were much better in the later period.

1980-2010 real:
STT 3.8%
ITT 4.9%
LTT 5.7%

Note that the 1940s are not included, and this was one of the worst periods for real returns for bonds, especially shorter-term bonds, due to high inflation coupled with interest-rate controls that held nominal rates very low (3-month Treasury held to 3/8 percent from 1942-1947).

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by HomerJ » Sat Jan 21, 2017 2:45 pm

livesoft wrote:
btenny wrote:Well lots of comments. Last night I did some year end account reconciliation. I found that both my bond taxable funds had gone down price wise by about 4% or so between August and December. That is a big hit for a .25% rate change.
But the 10-year Treasury interest rate went up a full 1% in that time frame. This shows that the Fed Funds Rate is perhaps not what one should be looking at.
This. The Fed rate went up from 1% to 5% over 2 years from 2004-2006... Bonds were not destroyed, because other interest rates did not follow as high.

Fed rate is not the only determinant of interest rates.

Watching the fed rate isn't as helpful as you think.

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patrick013
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by patrick013 » Sat Jan 21, 2017 3:50 pm

bikenfool wrote:
patrick013 wrote:Image

Well now that we're supposed to be starting a secular trend of
rising rates (left side of graph) perhaps we'll never see TRSY's
at less than 3% again. When predictions (forewarnings) become
reality or "perfect information" as information has become in the
past that will be nice.
I'm having a hard time believing 2.2% total return on the left side of the chart. A simple example: If I buy a bond in 1950 and hold it until maturity I'll make a little more than 2%. In 1960 my coupon is about 4%, 1970 about 6%. So I would expect total return around 4% in this period. Perhaps the total return quoted is real and the coupon is nominal?
Here's the author's explanation :

In the 31-year period of rising rates from 1950 to the peak in 1981, total return for the 10-year
Treasury index (used as a proxy for bond funds throughout this paper) averaged 2.2% even
though the average coupon over the period was 5.6%. If rates begin to rise again over the next
few years, bond fund investors may experience the same disappointing total return.


The author is a Phd. from the University of San Francisco and has high regard
for bond ladders. :)
age in bonds, buy-and-hold, 10 year business cycle

kenner
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by kenner » Sat Jan 21, 2017 4:26 pm

patrick013 wrote:
Here's the author's explanation :

In the 31-year period of rising rates from 1950 to the peak in 1981, total return for the 10-year
Treasury index (used as a proxy for bond funds throughout this paper) averaged 2.2% even
though the average coupon over the period was 5.6%. If rates begin to rise again over the next
few years, bond fund investors may experience the same disappointing total return.


The author is a Phd. from the University of San Francisco and has high regard
for bond ladders. :)
I have no reason to doubt the author's educational qualifications. But the post-WWII era, when U.S. treasury credit reigned supreme globally (almost zero credit risk vis-a vis the rest of the world), might not be predictive of future bond price performance, even in a period of sustained rising interest rates. After all, a large number of investors today buy bond funds such as Total Bond Market that invest in securities across many risk sectors (corporate, MBS, etc.).

What I'd like to see from the PhD. is an accurate projection of bond returns for the next 31 years. Most of us can "predict" the past.

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patrick013
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by patrick013 » Sat Jan 21, 2017 5:02 pm

kenner wrote:
patrick013 wrote:
Here's the author's explanation :

In the 31-year period of rising rates from 1950 to the peak in 1981, total return for the 10-year
Treasury index (used as a proxy for bond funds throughout this paper) averaged 2.2% even
though the average coupon over the period was 5.6%. If rates begin to rise again over the next
few years, bond fund investors may experience the same disappointing total return.


The author is a Phd. from the University of San Francisco and has high regard
for bond ladders. :)
I have no reason to doubt the author's educational qualifications. But the post-WWII era, when U.S. treasury credit reigned supreme globally (almost zero credit risk vis-a vis the rest of the world), might not be predictive of future bond price performance, even in a period of sustained rising interest rates. After all, a large number of investors today buy bond funds such as Total Bond Market that invest in securities across many risk sectors (corporate, MBS, etc.).
The author's figures do add up then and his strategy to offset rising rates
is the bond ladder. Another strategy is to have your bonds set for a target
date maturity, like 2020, based on the peak predicted in 2019 for the FFR.
My personal favorite is just shortening maturity when rising rate predictions
are repeated and repeated. Buy a ST Investment Grade Bond Fund and just
ride it out then. Switch to a LT fund when rate lowering predictions are repeated
and repeated. Easy. I am not a big fan of TBM. I try to get a copy of every
rate schedule the Fed publishes and that's what I use. Granted that schedule
doesn't become reality quickly like it used to but it does give advance notice of
coming rate hike intentions.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by kenner » Sat Jan 21, 2017 5:14 pm

patrick013 wrote:
The author's figures do add up then and his strategy to offset rising rates
is the bond ladder. Another strategy is to have your bonds set for a target
date maturity, like 2020, based on the peak predicted in 2019 for the FFR.
My personal favorite is just shortening maturity when rising rate predictions
are repeated and repeated.
Being lazy, and as a long-term "big picture" guy, I agree that high quality, short term bond funds are a good option for bond-squirmish investors. For investors with a long-term investment time horizon - and an appropriately determined asset allocation - taking risk on the equity side makes sense.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by RAchip » Sun Jan 22, 2017 4:43 pm

"The Fed rate went up from 1% to 5% over 2 years from 2004-2006... Bonds were not destroyed, because other interest rates did not follow as high."


This is a logical argument. On June 25, 2003 the FFR was 1% but the 10yr was 4.25%. On June 29, 2006 the FFR had risen to 5.25% but the 10yr yield had only risen to 5.37%. The difference between that situation and now is that then when the FFR started rising the 10yr was already 4.25%.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by Kevin M » Sun Jan 22, 2017 5:54 pm

RAchip wrote: This is a logical argument. On June 25, 2003 the FFR was 1% but the 10yr was 4.25%. On June 29, 2006 the FFR had risen to 5.25% but the 10yr yield had only risen to 5.37%. The difference between that situation and now is that then when the FFR started rising the 10yr was already 4.25%.
We have to go back to the 1950s to find similarly low yields. Here we can find:

Code: Select all

Date        FFR   10yr
---------   ----  ----
Jul 1954    0.25  2.30
Feb 1956    2.50  2.84
https://fred.stlouisfed.org/graph/?g=csbi

So FFR increased by 205 basis points while 10-year Treasury increased by only 54 basis points.

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

kenner
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by kenner » Sun Jan 22, 2017 6:21 pm

Kevin M wrote: We have to go back to the 1950s to find similarly low yields. Here we can find:

Code: Select all

Date        FFR   10yr
---------   ----  ----
Jul 1954    0.25  2.30
Feb 1956    2.50  2.84
https://fred.stlouisfed.org/graph/?g=csbi

So FFR increased by 205 basis points while 10-year Treasury increased by only 54 basis points.

Kevin
It's almost as if market forces along the yield curve do not always move in lock-step with Fed rate changes.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by btenny » Sun Jan 22, 2017 7:23 pm

KEVIN. Very good data. Thanks.

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by patrick013 » Sun Jan 22, 2017 8:44 pm

kenner wrote: It's almost as if market forces along the yield curve do not always move in lock-step with Fed rate changes.
Yes it would/does take longer to catch up than a lock-step but theoretically
it's supposed to catch up. FFR to TRSY10 correlation is actually 90 %.
But a good yield spread strategy is buy when the spread is 1.5% to 2% or
even more over the FFR. Sometimes I thing sellers are just buy-and-hold
investors and won't sell unless they receive a super premium price.

Here's the FFR-TRSY10 data :
Image

And here's a very basic statistical forecast based solely on the FFR :
(don't know what else to put in it)
Image
age in bonds, buy-and-hold, 10 year business cycle

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Re: Fed Rate to 3%

Post by anoop » Sun Jan 22, 2017 9:27 pm

letsgobobby wrote: 3 years from now is a long time. personally I do not believe the overnight rate will be 3% in 2019. I am planning to buy my usual allocation of EE bonds this year (3.5% over 20 years) and almost nothing she could say would change my mind about it.
If we think in terms of simple interest, which is how t-bonds pay, the interest for EE bonds is actually 5%. :)

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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by nisiprius » Mon Jan 23, 2017 9:22 am

Somewhat tangentially, but it's a complicated idea that I don't think I've seen explained... Phineas T. Whoopee came close in his remark about yields and prices being mathematically related.

What exactly do we mean by "the prevailing interest rate?"

We have a universe of individual bonds, with individual credit ratings, terms, coupons, and, worst yet, different "deals" (as in whether they can be called), and we have people selling and buying them in a somewhat auction-like manner in which people agree on prices.

There isn't some big interest rate in the sky that controls it all.

Even the Fed isn't quite controlling anything, not even the overnight rate if I understand what someone told me in this forum once. It participates in the market like everyone else, except that, being the multi-trillion-pound gorilla it is, it has a lot of influence.

What is the case, however, is that because bonds promise specific numbers of dollars to be paid on specific dates (except for those that don't, and except for the possibility that they won't keep the promise), you can do math that says "if I am willing to pay $X for this bond, then it is a logical consequence that if I am willing to pay $Y for this other bond." And the number that links them all together, which is really a mathematical abstraction, is the "interest rate."

If I buy a bond with no premium or discount for $1,000, and it has a 1% coupon, and I find today that nobody is willing to pay me $1,000 for that bond, then I conclude that "the" interest rate must have risen. And in fact the collection of prices that buyers and sellers are willing to agree on for particular bonds--if they have essentially perfect credit quality and no other risk factors like call risk--all match up neatly and are connected by a number that is common to everybody's calculations.

The calculation is sometimes based on a sort of financial dissection puzzle in which you say "OK, you own a bond that is going to pay $10 every January and July and $1,000 in January, 2022" and actually calculate a portfolio of newly-issued bonds you could buy today that will pay exactly the same amounts on exactly the same days... and cost less than $1,000. Obviously (?) then "the" value of the bond is the cost of the bond portfolio that you could use as a replacement.

It's a little bit of a chicken-and-egg problem to say which comes first, the collection of bid-and-asked prices or "the prevailing interest rate," but I think it's really the collection of prices.
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Re: Fed Rate [may go] to 3% - [investing consequences?]

Post by patrick013 » Mon Jan 23, 2017 3:33 pm

Keynes once said the Loans Available Theory was the directive of
all interest rates. A few years later he decided that the Liquidity
Preference Theory was a more advanced and therefore a better
theory to explain the publication of interest rates in the yield curve.

I've got to stop reading these old economics books, but, there is a
positive yield curve slope 90% of the time. :)
age in bonds, buy-and-hold, 10 year business cycle

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