Bonds…And Rising Interest Rates….

[Coronita]

Ok. So I hate bonds…Because maybe just that I’m an idiot and don’t understand them well enough… But to me they seem fakey safe investments… By that I mean, on paper, they seem to look like a safe investment.. Invest X ,get Y% return year over year…But to me they don’t seem to be as “safe” as people make them out to be…

What is the ideal economic situation do you make money on a buying bonds?

(Simplifying assumption is that that bond is for a “safe” investment… It’s yield is not dependent on credit worthiness of company/institution/etc)….

It seems like the ideal situation would be if you bought a bond that costs $X with yield Y%, and then you have a prevailing interest rate that continues to fall… so that the price of the bond goes up…

So does this mean, in the opposite environment, in which you have a environment where you have a perpetual rising interest rate environment, that the bond value will start to get killed?

If so, why would one want to buy bonds if one anticipates we’ll have an environment where interest rates will be rising steadily?

I’ll admit, I never bothered to really dig into bonds, beyond just picking an index fund out of a basket of other index funds. And thus far have been lucky….

But curious/inquiring minds now want to know.

[SD Realtor]

What is the ideal economic situation do you make money on a buying bonds?

Conditions similar to 1980-1984.

[SK in CV]

[quote=SD Realtor]What is the ideal economic situation do you make money on a buying bonds?

Conditions similar to 1980-1984.[/quote]

Yes. Buy at the end of 1980 and sell at the end of 2008. And short right before the fed realizes it can’t protect bond holders from inflation forever. I have no idea when that will be.

[Coronita]

[quote=SD Realtor]What is the ideal economic situation do you make money on a buying bonds?

Conditions similar to 1980-1984.[/quote]

So from what I recall, 1970’s was a period of high inflation. And early 80ies was a period of falling interest rates…

So with that, aren’t we in a period right now with falling rates (albeit artificially created), and does that at least partly explain why bonds have been doing pretty well in their returns since the price of bonds have been increasing?

And if so, if one expect rates in the near-mid future to start to rise aggressively and continue to rise, wouldn’t that make bonds a really really really bad investment in the coming years?

I keep seeing people say that with rising interest rates, the RE market property value is gonna fall…We’ve been through periods of high inflation and high interest rates in the past…Have we seen huge corrections in RE as a result of rising interest rates (minus the liar loan/bubble periods)?
It seems like there are so many variables when it comes to property, and the value is less correlated to rising interest rates, historically speaking…

On the other hand it seems like there is much higher correlation between rising interest rates and bonds, and that bonds will get slaughtered during a period of increasing interest rates…

Thoughts?

[Coronita]

[quote=SK in CV][quote=SD Realtor]What is the ideal economic situation do you make money on a buying bonds?

Conditions similar to 1980-1984.[/quote]

Yes. Buy at the end of 1980 and sell at the end of 2008. And short right before the fed realizes it can’t protect bond holders from inflation forever. I have no idea when that will be.[/quote]

You can short bonds? (Not saying I’m gonna do it. Just curious)

[SK in CV]

[quote=flu][quote=SK in CV][quote=SD Realtor]What is the ideal economic situation do you make money on a buying bonds?

Conditions similar to 1980-1984.[/quote]

Yes. Buy at the end of 1980 and sell at the end of 2008. And short right before the fed realizes it can’t protect bond holders from inflation forever. I have no idea when that will be.[/quote]

You can short bonds? (Not saying I’m gonna do it. Just curious)[/quote]

Yeah, a few different ways. The simplest would be plays using ETFs. TLT is a straight bond fund that can be optioned. Or TBT is an ultra short (2x i think?) fund. Or you can even sell puts or buy calls on it. Be careful with that one. You’re trading a product that’s already a double inverse fund. So if you think the market is gonna tank, you want to go long on it. Don’t wanna get caught being right, but trading wrong.

[SD Realtor]

Yes you can short them with the vehicles that SK made note of. However you more then likely get killed because those etfs hammer you. Your movement is only from opening to closing. When gaps happen overnight you do not benefit.

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Look at the tnx from 79 to 84. Just think how life would have been if you bought 30 year bonds at that time?

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FLU you spoke of buying bonds. If you meant trading bonds that is an entirely different matter. Talk to Chris, the email I sent you, he is a bond trader.

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Some day, I don’t know when, I will buy bonds and sit on them for income… At this rate, it looks like that day is far far away. It will come though.

[CA renter]

[quote=flu][quote=SD Realtor]What is the ideal economic situation do you make money on a buying bonds?

Conditions similar to 1980-1984.[/quote]

So from what I recall, 1970’s was a period of high inflation. And early 80ies was a period of falling interest rates…

So with that, aren’t we in a period right now with falling rates (albeit artificially created), and does that at least partly explain why bonds have been doing pretty well in their returns since the price of bonds have been increasing?

And if so, if one expect rates in the near-mid future to start to rise aggressively and continue to rise, wouldn’t that make bonds a really really really bad investment in the coming years?

I keep seeing people say that with rising interest rates, the RE market property value is gonna fall…We’ve been through periods of high inflation and high interest rates in the past…Have we seen huge corrections in RE as a result of rising interest rates (minus the liar loan/bubble periods)?
It seems like there are so many variables when it comes to property, and the value is less correlated to rising interest rates, historically speaking…

On the other hand it seems like there is much higher correlation between rising interest rates and bonds, and that bonds will get slaughtered during a period of increasing interest rates…

Thoughts?[/quote]

Correct, you want to be buying bonds when rates are high and about to fall. That makes the value of your bonds go up because the higher yield of your bonds (relative to lower yields in the future) will command a premium. You get asset appreciation (price of the bonds you hold), and it’s very, very nice to be getting say 10% yields when everyone else is getting 5% yields.

IMHO, during periods of ZIRP, you should be getting ready to short bonds, but you can also get killed if your timing isn’t right, depending on how you do it and your time-frame for holding the bonds. Personally, I would love to short bonds, but the Fed is making the timing of that very difficult.

Whoever gets the timing right will be very lucky because they can get the return on their short positions, and then buy assets when rates are high (and prices of those assets are low). There is not always a 1:1 correlation between interest rates and asset prices (like houses), but that’s because there are many other variables in play. In the 70s and 80s, you had women entering the workforce en masse, and Baby Boomers were entering their peak buying years. This pushed the prices of assets up even though interest rates were rising. We are on the opposite end of that situation now, though, which is why I am a deflationist…while also acknowledging the potential for a currency crisis of sorts.

If you can hold all other variables constant, then asset prices — especially those that are dependent on credit, like houses — would fall when rates rise. If you doubt this, ask yourself why the Fed has been hammering rates down during the entire housing/credit bubble bust.

[SD Realtor]

Pretty much yes what you said is true. However most bond holders (not traders) don’t purchase them for appreciation, but rather income. The simple intent is to hold them to maturity and collect the income. That is why you hear about retirees purchasing them.

In a free market yes I would agree with you. I am sure you have heard many a pundit talk about that bond bubble we are in. Many consider this to be the final bubble, that is, when (not if) this bubble pops there will be hell to pay. As you know the market is anything but free and as we saw in Japan, rates can be kept low a pretty damn long time.

Like I said, the reverse ETFs offered give you the opportunity to be a bond bear but they don’t operate as much in your favor as you think they would.

[Coronita]

[quote=CA renter]
If you can hold all other variables constant, then asset prices — especially those that are dependent on credit, like houses — would fall when rates rise. If you doubt this, ask yourself why the Fed has been hammering rates down during the entire housing/credit bubble bust.[/quote]

Um… historical data doesn’t seem to support this…Between late 70ies to mid 80ies, didn’t interest rates rise from roughly 9% to 18%? But during that period, home prices gained 30%….

Any financial gurus can offer an explanation?

[Coronita]

So it sounds like the worst thing one can do is holding stuff in cash like 1% CD and just waiting 5,10,15+years.

[CA renter]

[quote=flu][quote=CA renter]
If you can hold all other variables constant, then asset prices — especially those that are dependent on credit, like houses — would fall when rates rise. If you doubt this, ask yourself why the Fed has been hammering rates down during the entire housing/credit bubble bust.[/quote]

Um… historical data doesn’t seem to support this…Between late 70ies to mid 80ies, didn’t interest rates rise from roughly 9% to 18%? But during that period, home prices gained 30%….

Any financial gurus can offer an explanation?[/quote]

It was in my post, above:

[quote=CA renter]

There is not always a 1:1 correlation between interest rates and asset prices (like houses), but that’s because there are many other variables in play. In the 70s and 80s, you had women entering the workforce en masse, and Baby Boomers were entering their peak buying years. This pushed the prices of assets up even though interest rates were rising. We are on the opposite end of that situation now, though, which is why I am a deflationist…while also acknowledging the potential for a currency crisis of sorts.
[/quote]

Those “other variables” were not held constant.

[CA renter]

Something else to consider:

——–
“A decision by the Federal Reserve to expand its bond buying next week is likely to prompt policy makers to rewrite their 18-month-old blueprint for an exit from record monetary stimulus.

Under the exit strategy, the Fed would start selling bonds in mid-2015 in a bid to return its holdings to pre-crisis proportions in two to three years. An accelerated buildup of assets would also mean a faster pace of sales when the time comes to exit — increasing the risk that a jump in interest rates would crush the economic recovery.

“There is certainly an issue about unwinding the balance sheet” in a way that “is effective and continues to support the recovery without creating inflation,” St. Louis Fed Bank President James Bullard said in an interview in October. The central bank might have to “revisit” the 2011 strategy, he added.

The Fed is already buying $40 billion a month in mortgage- backed securities to boost the economy, and policy makers meeting Dec. 11-12 will consider whether to purchase more assets. John Williams, president of the San Francisco Fed, has proposed adding $45 billion of Treasury securities a month.

The bigger the balance sheet, “the riskier the exit becomes,” Richmond Fed President Jeffrey Lacker said during a Nov. 20 speech in New York. “That is something we need to think carefully about.”

Krishna Memani, director of fixed income at OppenheimerFunds Inc., said a too-rapid sale of assets risks disrupting the $5.2 trillion market for agency mortgage debt.”

http://www.bloomberg.com/news/2012-12-07/fed-exit-plan-may-be-redrawn-as-assets-near-3-trillion.html

[EconProf]

Historically, rapid increases in the money supply and generally liberal fiscal policy combined with stimulative monetary policy has resulted in inflation. This inflation prompts higher interest rates, which causes the market prices of existing bonds (with their fixed interest rates) to fall.
We’ve now had many years of such monetary and fiscal stimulus and yet have low inflation and still-falling interest rates. Do the old rules no longer apply? Or do they just not apply yet, and will some day hit us with a vengence?
I’ve been wrong myself in predicting a return of inflation and rising interest rates, so am giving up on predictions.
The old rule about the time lag between a change in monetary policy and the resulting impact on the real economy–whether to tighter or looser–was about eighteen months. Well, that rule is certainly out the window.
It appears that other forces that affect inflation, interest rates, and expectations are overwhelming the stimulative effect of easy money: The deep recession, deleveraging, and especially the economic weakness of the rest of the world making the dollar look relatively safe.
For those of you who believe inflation will result eventually, shorting bonds is one way to put your money where your beliefs are.

[SD Realtor]

“So it sounds like the worst thing one can do is holding stuff in cash like 1% CD and just waiting 5,10,15+years”

Tough call man. Obviously we are careening down an icy road with no brakes. Monetizing our own debt… it is all a recipe for disaster.

In part the flip problem we have is due to the fact that there are no returns available. When we did our flips we had a 20% target. We got out when our last deal yielded 7 or 8%. Now I see guys happy with 5% as a target! They have groups of people who are happy with that as well.

There is no place for the money to go. Can’t buy bonds… These days to make money on equities you have to be good at that rigged game. Returns on flips are tough now. Rentals are okay but you need to find the right market. Precious metals… maybe but I don’t know.

I don’t have an answer for ya dude. These are uncharted waters for sure.

[Author]

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