Rising Interest Rates and Bonds
With FOMC in focus this week and a general understanding that interest rates are going to rise I did some digging on one way to play a rising interest rate scenario.
Key Points
First some basics:
A bond is a fixed-income instrument that represents a loan made by an investor to a borrower. This bond will pay out at a fixed or variable interest rate called a coupon rate. Bond prices and it's yields inverse each other. The higher a bond price(or par value) rises the lower it's yield will fall. When interest rates rise bond prices generally decline as bonds are issued with the higher interest rate. Say you bought a bond yielding 5%. If a rate increase of say .5% happens before maturity suddenly your bond that yields 5% doesn't look as good as the new ones that are yielding 5.5%. This causes your bond to be worth less than what you initially paid for it. This .5% increase isn't a huge deal if your bond expires in 3 months. But when you start to look at bonds that expire in 5,10,20 years you really start to see the effects of missing out on that .5%.
TLT tracks the bond prices of the 20 year treasury bonds. On the weekly TLT has put in another lower low, TTM is showing a squeeze currently pointed downward, and closed right at resistance. However over the past few days TLT has shown a few really nice candles with momentum starting to shift positive. I think some of this shift could be attributed to investors seeking some safer returns in the market selloff. Going long here before the FOMC meeting could prove to be an issue for those investors. I'm looking to short TLT if the daily momentum can start to shift in a negative manner and it doesn't put in a new higher high. If it does continue to shift positive and make that higher high will look to get into a short term long. I'm cautiously optimistic that we get some sort of relief bounce here on the indices which could also help with the short. I won't be making any moves until after the FOMC announcement on Wednesday though.
Another thing to keep an eye on is the CPI reading in Feb. If inflation continues to come in higher than expected we could see short term bond prices begin to suffer. I don't think that reading will matter as much for the longer term (10+) year bonds. Lastly interest rate decisions generally take about a year before you start seeing any effects.
Key Points
- Bond price tend to underperform during periods of interest rate rising
- Longer bonds are more susceptible
- Shorting TLT could be a potential option
First some basics:
A bond is a fixed-income instrument that represents a loan made by an investor to a borrower. This bond will pay out at a fixed or variable interest rate called a coupon rate. Bond prices and it's yields inverse each other. The higher a bond price(or par value) rises the lower it's yield will fall. When interest rates rise bond prices generally decline as bonds are issued with the higher interest rate. Say you bought a bond yielding 5%. If a rate increase of say .5% happens before maturity suddenly your bond that yields 5% doesn't look as good as the new ones that are yielding 5.5%. This causes your bond to be worth less than what you initially paid for it. This .5% increase isn't a huge deal if your bond expires in 3 months. But when you start to look at bonds that expire in 5,10,20 years you really start to see the effects of missing out on that .5%.
TLT tracks the bond prices of the 20 year treasury bonds. On the weekly TLT has put in another lower low, TTM is showing a squeeze currently pointed downward, and closed right at resistance. However over the past few days TLT has shown a few really nice candles with momentum starting to shift positive. I think some of this shift could be attributed to investors seeking some safer returns in the market selloff. Going long here before the FOMC meeting could prove to be an issue for those investors. I'm looking to short TLT if the daily momentum can start to shift in a negative manner and it doesn't put in a new higher high. If it does continue to shift positive and make that higher high will look to get into a short term long. I'm cautiously optimistic that we get some sort of relief bounce here on the indices which could also help with the short. I won't be making any moves until after the FOMC announcement on Wednesday though.
Another thing to keep an eye on is the CPI reading in Feb. If inflation continues to come in higher than expected we could see short term bond prices begin to suffer. I don't think that reading will matter as much for the longer term (10+) year bonds. Lastly interest rate decisions generally take about a year before you start seeing any effects.
Comment:
Looks like TLT is reacting to FOMC news and headed downwards. Will be interesting to see this play out