Should I sell bond fund because FED's heads-up on rate increase?

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MikeT
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Should I sell bond fund because FED's heads-up on rate increase?

Post by MikeT » Sat Mar 04, 2017 8:26 pm

If I understand it correctly, a rise in interest rates will devalue existing bonds funds.

So, based on the FED's heads-up that it will increase rates, should I sell my medium term bond funds and go short-term (or even to cash), and then re-buy them after the rates go up?

Really: I'm not a market timer but how often do you get an insider tip from the folks who actually control the interest rate?

Thanks,
Mike

Doom&Gloom
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by Doom&Gloom » Sat Mar 04, 2017 8:29 pm

MikeT wrote:If I understand it correctly, a rise in interest rates will devalue existing bonds funds.

So, based on the FED's heads-up that it will increase rates, should I sell my medium term bond funds and go short-term (or even to cash), and then re-buy them after the rates go up?

Really: I'm not a market timer but how often do you get an insider tip from the folks who actually control the interest rate?

Thanks,
Mike


Well, since you got it before millions of other people did ...

Wait, never mind.

MikeT
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by MikeT » Sat Mar 04, 2017 8:34 pm

Thanks @Doom&Gloom :-) (love that name).

So it's not just the actual interest rate that affects the value of bond funds but also perceived possible future interest rates?

Interesting!

Mike

Geologist
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by Geologist » Sat Mar 04, 2017 8:34 pm

But in fact "the folks who actually control the interest rate" don't actually control the interest rates on medium-term bonds. What the Fed controls (and Yellen suggest would be changed in March) is the overnight rate. How medium-term rates would respond to this change in ultrashort term rates can be unpredictable.

Beyond that, you can find many threads here on why jumping around in anticipation of Fed rate changes is market timing and a foolish approach.

livesoft
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by livesoft » Sat Mar 04, 2017 8:36 pm

Check out the following chart of two bond funds. You may already be too late to be thinking about selling. You may even want to be buying low right now. Who knows?

Image

If you see that BND has gone up 0.5% during the day, then before the market close I would sell some (not all) of my bond fund shares.
This signature message sponsored by sscritic: Learn to fish.

MikeT
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by MikeT » Sat Mar 04, 2017 8:44 pm

Funny you say that.

As a separate but related question: I have some money sitting in an ALLY savings account at 1% what I want to invest. It's my tier 2 or 3 emergency fund so I don't want to go with all equities.

I was thinking about maybe:
Vanguard Wellesley Income Fund Admiral Shares (VWIAX)
https://personal.vanguard.com/us/funds/snapshot?FundId=0527&FundIntExt=INT

But since it's 60% bonds, maybe I should wait till the interest rates actually increase?

Mike

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grabiner
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by grabiner » Sat Mar 04, 2017 10:27 pm

MikeT wrote:Funny you say that.

As a separate but related question: I have some money sitting in an ALLY savings account at 1% what I want to invest. It's my tier 2 or 3 emergency fund so I don't want to go with all equities.

I was thinking about maybe:
Vanguard Wellesley Income Fund Admiral Shares (VWIAX)
https://personal.vanguard.com/us/funds/snapshot?FundId=0527&FundIntExt=INT


Wellesley is a fine fund, but it isn't a good fund for an emergency fund. It holds long-term bonds, and stocks, neither of which is suitable for an emergency fund. It is also a poor investment for a taxable account, because the corporate bonds and stock turnover create large tax bills. It's fine for a moderately low-risk IRA.

But since it's 60% bonds, maybe I should wait till the interest rates actually increase?


This is the same question as on the rest of the thread. Bond traders price long-term bonds to account for their expectations of future rate increases. If you sell a bond, you are selling it to someone else who already knows about the likely rate increases, and who will only offer you a price which compensates for the potential future losses. Conversely, if you buy a bond, you are buying it from someone who already knows about the likely rate increases, and needs to offer you a price which compensates for the potential future losses. Either way, you get a fair price.
David Grabiner

MikeT
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by MikeT » Sat Mar 04, 2017 10:34 pm

Well said @grabiner on both points, thanks!

Mike

pyld76
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by pyld76 » Sat Mar 04, 2017 11:28 pm

The bond market has already (to the extent possible) priced in the Fed information.

This is a pretty classic AA decision, regardless of the rate environment. I've always figured that if the fund's duration is shorter than my anticipated holding period, I'm not particularly bothered by what the rate environment is doing. Smarter people than I on fixed income will certainly come along and offer a better theory but if you own, say, BND and plan to own it for more than 6-8 years, do nothing.

aqan
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by aqan » Sun Mar 05, 2017 12:26 am

MikeT wrote:If I understand it correctly, a rise in interest rates will devalue existing bonds funds.

So, based on the FED's heads-up that it will increase rates, should I sell my medium term bond funds and go short-term (or even to cash), and then re-buy them after the rates go up?

Really: I'm not a market timer but how often do you get an insider tip from the folks who actually control the interest rate?

Thanks,
Mike

have you looked at the duration of your bond funds? thats the number you need to be aware of.
If the duration is lets say 10, then the fund will fall by approximately 10% if the risk free rate were to go up by 1% overnight. Now that said, all the rate information is public and the market has already priced all that into the bond (at least for next rate hike).

Dancer
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by Dancer » Sun Mar 05, 2017 2:26 am

Expectations for the next rate hike are built in....

If the hike is higher than expected, bonds may go down.

If lower than expected , bonds might go up.

If bonds go down / rates go up, more investors may buy them, driving up the price.

Forecasting is complex....

While Wellesley might have a longer duration than total bond, I don't consider it long term. Longer term intermediates maybe
[Edit: Wellesley duration as of 1/31/17: 6.4. Total bond: 6.1.]

I use it. In taxable. Suboptimal tax wise, but a set and forget conservative fund that felt right to me after 2008 / 2009.

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grabiner
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by grabiner » Sun Mar 05, 2017 9:28 am

aqan wrote:have you looked at the duration of your bond funds? thats the number you need to be aware of.
If the duration is lets say 10, then the fund will fall by approximately 10% if the risk free rate were to go up by 1% overnight. Now that said, all the rate information is public and the market has already priced all that into the bond (at least for next rate hike).


Even this is not correct. If a fund has a 10-year duration, the fund will fall by 10% if the rate on the bonds in that fund rises by 1%. The "risk-free rate" is usually defined as the rate on short-term Treasury bills, but long-term rates are less volatile than short-term rates. if the Fed unexpectedly raises rates by 1%, it is not likely that ten-year bond rates will rise by the same 1%.
David Grabiner

aqan
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by aqan » Sun Mar 05, 2017 11:26 pm

grabiner wrote:
aqan wrote:have you looked at the duration of your bond funds? thats the number you need to be aware of.
If the duration is lets say 10, then the fund will fall by approximately 10% if the risk free rate were to go up by 1% overnight. Now that said, all the rate information is public and the market has already priced all that into the bond (at least for next rate hike).


Even this is not correct. If a fund has a 10-year duration, the fund will fall by 10% if the rate on the bonds in that fund rises by 1%. The "risk-free rate" is usually defined as the rate on short-term Treasury bills, but long-term rates are less volatile than short-term rates. if the Fed unexpectedly raises rates by 1%, it is not likely that ten-year bond rates will rise by the same 1%.


well... it may not be the text book definition but its close enough for someone who's trying to determine how two separate bonds will behave if fed raises rates. i.e. duration is the measure of riskiness of a bond. the higher the duration more it falls if the rates rise (and vice-versa).

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Phineas J. Whoopee
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Re: Should I sell bond fund because FED's heads-up on rate increase?

Post by Phineas J. Whoopee » Mon Mar 06, 2017 3:28 pm

aqan wrote:...
well... it may not be the text book definition but its close enough for someone who's trying to determine how two separate bonds will behave if fed raises rates. i.e. duration is the measure of riskiness of a bond. the higher the duration more it falls if the rates rise (and vice-versa).

The difficultly may be the term rates, especially as a plural.

The main monetary policy tool the Fed uses is the Federal Funds Rate, singular. It's a target, but each day's effective rate is not directly controlled by the Fed. They do measure and report it.

The Federal Funds Rate is the target for the rate at which banks lend each other bank reserves overnight. Bank reserves are money banks keep on hand to meet daily business needs rather than lending it out. It includes cash in their physical vaults, and money held on deposit with their regional federal reserve bank. True reality is more detailed, but a close-enough approximation is they are required to keep at least 10% of the total of consumer checking accounts in reserve.

Random day-to-day fluctuation in business means some banks will end each day with more than the required amount of reserves, and others with too little.

The Federal Funds Rate is the target the Fed sets for the banks with excess to lend reserves, overnight (which includes over-weekend), to the most creditworthy banks which happened to come up short.

That's the rate, singular. The Fed does not set rates, plural (this is a minor simplification). The Fed neither pays nor receives the Federal Funds Rate.

Now, changes to the Federal Funds Rate change business conditions for banks. Each makes its own decisions about how much they will pay for deposits, and charge for loans. Over periods of months those decisions percolate through the financial system, and have an effect on how much investors are willing to accept for lending money in the form of bonds, but it is not a one-to-one effect, and it is different for different maturities and credit qualities. It's entirely possible for an unexpected Federal Funds Rate increase to reduce yields, and thereby increase prices, of already-issued longer-term securities.

That's both the textbook definition and how the system in fact works.

The Fed does not set bond yields. It has influence on some, but not control.

Does that help with why the Federal Funds Rate and bond yields are decoupled, yet not without influence on each other?

PJW

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