Bond prices go down when interest rates rise and vice versa. How is that? Well, think of it this way.
Imagine you bought a 10-year Treasury bond with $1,000,000 at the end of last year when the interest rate was 1.5%. That implies $15,000 of annual interest payments over the next ten years until maturity at which point you also get your $1,000,000 principal back.
However, the interest rate for 10-year treasuries has since risen to ~3.5%. So, who’s going to want the 1.5% bond when they can go buy essentially the same 10-year bond and get 3.5%? Nobody. Therefore, the price of the 1.5% bond must fall to attract buyers so that the yield-to-maturity is aligned with prevailing interest rates.
That means the bond you bought for $1,000,000 is now worth about $800,000 (roughly). However, it’s still going to mature at $1,000,000 in ten years so you’ll get the $200,000 appreciation (accretion) from the current price back to the maturity (par) value PLUS the $15,000 of annual interest over the ten years, but you took a 20% hit in the meantime.
So, although stocks are down over 20% this year, bonds are also down albeit to a lesser extent (US Aggregate Bond Index down 12.5% broadly).
So what’s the good news?
The good news is that fixed income investors finally can earn some interest on their fixed income investments!
Going back to our example above, now the buyer of a 10-year Treasury bond will receive $35,000 of annual interest on $1,000,000 instead of just $15,000 a year! That’s about 2.3x the interest income each year for the next ten years.
Another example, is a 2-year treasury bill that merely a year ago paid just 0.2% of annual interest. Today, a 2-year treasury bill pays 3.4% for a 17x increase in interest income! That’s why I’ve been telling clients to pull excess cash out of the bank earning near-0% and invest that excess cash into 1-year and 2-year treasury bills.
Below is a chart of the interest rates for 2-year (purple line) and 10-year (orange line) treasury bonds over the last twenty years.
The question on your mind may be where do rates go from here? I have an opinion on this I will share in my next commentary along with inflation as they are intertwined.
Past performance is no guarantee of future results. All investments maintain risk of loss in addition to gain.
Data from third-parties is believed to be reliable but accuracy is not guaranteed. Much of the data used to interpret the markets and forecast returns are often at odds with each other and can result in different conclusions. Many different factors impact prices including factors not mentioned here.
This is not investment advice but merely a general commentary. Individualized investment advice cannot be provided until a thorough review of your unique circumstances and financial goals is completed.
Views provided here are current only as of the moment of posting and are subject to change at any time without notification.