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Rising rates are the bond market’s boogeymen,
but the market doesn’t always react to them in the
same way.
Short-term rates—which are driven by the Federal
Reserve—have been kept as low as ever and for
longer than ever before. With the Fed poised to raise
them, some fear that market carnage will ensue.
Whether investors believe the Fed is acting too quickly,
too slowly, or perhaps not enough can make all
the difference.
That’s the message of the accompanying charts, one
from a period of Fed moves in the
2000
s and another
from the mid-
1990
s. During the former, the Fed
raised short-term rates roughly
4
percentage points
between March
2004
and June
2006
. Compared
with some earlier cycles, the reaction was measured.
Yields for
10
- and
30
-year Treasuries didn’t rise
anywhere near as much as short-term rates did (as
the first chart shows, leading to a “flatter” yield
curve), and the
10
-year bond lost
1
.
7%
, while the
30
-year bond actually gained
2
.
2%
.
Yet, things can get much worse. Rate cycles rarely
occur with the same speed, magnitude, or length,
and when the Fed acted in
1994
, investors pushed
up longer-term bond yields in tighter step with the
Fed’s short-term rate hikes. (The second chart shows
short- and long-term rates nearly moving in tandem,
a so-called parallel shift in the yield curve.) The
10
-year Treasury lost
7
.
9%
in
1994
; the
30
-year bond
slid more than
12%
.
That makes it extra tricky to predict how funds will
fare when the Fed chooses to act. There are a few
things we can say:
p
Some rate shifts, as those of
1994
, can be especially
damaging to long-duration funds: The long-term bond
Morningstar Category tumbled
6
.
8%
that year. Its
results during the March
2004
to June
2006
stretch
were much better (
0
.
76%
), but both showings left the
category near the very bottom of the fund universe.
p
The flip side is that short-duration funds almost
always perform better than others during rising-rate
periods, but the range can be wide from one rate
cycle to another, especially depending on how fast
the Fed chooses to move.
p
If the economy is healthy or gaining strength, you
can usually expect credit-sensitive funds to perform
better than higher-quality, longer-maturity fare.
p
Normally the last two items make bank-loan funds—
which hold floating-rate junky loans—star players.
The wild card this time is that, to attract investors
while rates have been low, many loans promised a
minimum level of income regardless of how low
short-term rates got. When short rates rise, though,
that means many loans won’t see their own rates
float up until short rates get above those floors.
K
Contact Eric Jacobson at
eric.jacobson@morningstar.comWhat Rising Rates Mean for
Your Bond Portfolio
Income Strategist
|
Eric Jacobson
Fed Funds Hikes: How the Market Responded in the Early 1990s
8.0
6.9
5.8
4.7
3.6
3
M
6
M
2
Y
3
Y
5
Y
10
Y
30
Y
p
12/30/94
p
09/30/94
p
06/30/94
p
03/31/94
p
12/31/93
p
09/30/93
Maturity
Yield (%)
Fed Funds Hikes: How the Market Responded in the Mid-2000s
5.5
4.5
3.5
2.5
1.5
3
M
6
M
2
Y
3
Y
5
Y
10
Y
30
Y
p
06/30/06
p
03/31/06
p
12/30/05
p
09/30/05
p
06/30/05
p
03/31/05
p
12/31/04
p
09/30/04
p
06/30/04
p
03/31/04
Maturity
Yield (%)