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Author: issender One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35387  
Subject: Re: Why should bond prices drop? Date: 1/9/2005 9:00 PM
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I'm not a Fixed Income expert, but let me take a stab at this.

You raise a fair point: if the bond market is anywhere near efficient, Greenspan's measured pace of 25 basis points ea. meeting should be priced into the market.

The rub is that
(1) when we say that prices reflect that, we have to be careful what maturities we talk about. The yield curve (which shows the yield as a function of time) need not move in a parallel fashion. Last year we saw the curve start to flatten as short term rates moved up more than long-term rates. So, when we say things are priced in, is this for each security and in the proper amount?

(2) Changes may affect instruments more/less than their durations would predict, given the markets prediction of how these rising rates will impact future inflationary expectations and economic growth. Here different portfolio managers will have different econometric models and get slightly different answers.

(3) No one (not even Greenspan himself) knows exactly where/when he will stop - he is just applying the brakes bit by bit. It is not like the Fed has a computer simulation it can run in a Monte-Carlo fashion to predict what GDP growth will be in a few quarters based on the actions it takes today.

If you are concerned about rising rates, just shorten your durations. Similiarly, if you are concerned about unexpected inflation, look into TIPS.

Hope this helps


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