I have noticed, on countless occassionns, on numerous boards, that everyone assumes interest rates will be going up in the not-so-distant future. Based on historical observations, this is probably true. However, people often mention the likelihood of rate hikes as a reason to not buy bonds / bonds funds at present.So now to the question:Aren't the markets set up to anticipate interest rate moves?Anyone who uses the likelihood of rate hikes as a reason to not participate in bonds seems to be saying they are anticipating something that the market hasn't priced in, or doesn't yet know about. In my view the likelihood of rate hikes should already be reflected in current yields, in a discounted fashion.-hack(although I think we could be enterring a japan-style era of deflation, so it could be 10-15 years before rates go higher. I happen to think the next FOMC will be to CUT rates. Only time will tell. If this does happen, bonds could continue to due well, and a 5 year CD at current rates would look like a genius move, in retrospect.).
Hack,I was thinking of writing basically what you wrote, but you beat me to it.We are in a low-inflation, low interest rate environment. Especially because of the baby-boomers saving for their retirements, there is a huge amount of liquidity out there. This liquidity is going to keep interest rates low for the next decade or so, until the population dynamics changes. Stocks are the competitive asset to cash, and as the returns on cash stay low, so will returns on stocks. That's my take.-dr.nonlinear-
Several brief points:1. The current interest rates are set so low that the Fed basically has no room to maneuver right now. This is a bad thing, because the Fed needs the room to maneuver in order to control the money market smoothly. 2. The current government is set to loosen the purse strings. I mean, we have budget deficit right now, which won't disappear any time soon. Plus wars, farm subsidies, and other things. And no cash. There are only that many ways to get out of this situation. One can print more government paper, or else one can print more money. The first scenario means that the yield curve for Treasuries will probably become much more upward-sloping than it is now: the government has to make its paper attractive, if it wants to sell it. The way to make paper attractive? Right, up the rate. The second scenario: inflation. IMO, this is a very likely way to finance at least a part of the current budget deficit. Why? Because inflation is a neat way to control the situation. The Fed sets the rates, and the Treasury prints enough cash to reach the inflation target. Between the two, the money markets are tightly controlled. 3. Should inflation become an issue, the dollar is going to fall. When it falls, there will be a 'flight to quality': people will be taking cash out of the US bonds and putting them into, say, EU-denominated bonds (which are way undervalued right now, due to cheap euro). 4. Who knows what will then happen to corporate paper? Not me. All in all, right now looks like a bad moment to get into US bond markets, in my opinion. 2195501y
I happen to think the next FOMC will be to CUT rates. Only time will tell. If this does happen, bonds could continue to due well, and a 5 year CD at current rates would look like a genius move, in retrospect.) Hack,You're betting that the current trough is only a consolidation in a secular downtrend? For the sake of discussion, I'll take the other side of that trade. The genius move was buying 5-year Treasuries at the Feb and May, 2000 auctions. Buying pure interest rate vehicles now, as opposed to company-specific issues, is high-stakes gambling, not investing or even careful trading. There are interest rates, and then there are interest rates, with the short end dominated by Fed policy and the long end by the bond market.With the discount rate currently at 1.75% and at a 30-year low and not even offering a real rate of return --i.e., interest on short-term money is less than inflation--, the smart bet has to be mean reversion, that short rates are headed higher in the near future. Originally the bond market was thinking as soon as May. Now they're saying August or so, and even the voting members of the FOMC committee are saying very openly that a re-adjustment to a neutral stance, from the present stimulative one, is going to happen fairly soon. How to play those "facts" is another matter, with the middle and long ends are even tougher to game, but I don't see anything obvious about the likelihood of more rate cuts. Yes, Bush's unfolding follies will force a flight to quality, pushing rates down temporarily, but the inflationary pressures of war will overwhelm the deflation we're currently importing and the bond market will want to be paid for the risks and rates will return to "historically normal" levels. At least, that's my bet and the way I'm trading this one. So, yes, "time will tell". But, since markets are continous auctions, not games that ever end, both of us will be proven to be both right and wrong, in time. But is the goal to be right, or to make money? and which bet is the more likely to pay off? The future can't be predicted, but present probablities can be calculated, and, IMHO, I think you're buying a lottery ticket, not an investment.Charlie
present probablities can be calculated, and, IMHO, I think you're buying a lottery ticket, not an investment.Charlie-i think we arrived at the same point, from different angles.My main point was in fact, that all of these probabilities should already be factored into the current yields. If correct, then avoiding bonds right now because of the proverbial "risk of rates going up" should be a non-issue (unless such a person has some sort of inside knowledge about rates that the market isn't aware of).(my point about the risk of deflation and protracted low rates -- 15 years, in the case of what happened to japan, was really just an aside)-hack
Hack,Wow. I didn't think we were agreeing at all. I understood you to be saying that buying 5-yr CD's now might prove to have been a shrewd purchase going forward, which, of course, no one will know until after the event. Furthermore, that you were saying that because the conventional wisdom is that rates are headed higher, it was likely to be one of those things that isn't so, just because everyone is so sure that it is going to be so. You were doing the smart, couragous, Foolish thing of trying to thinking ahead and apart from the crowd, and I was saying that this is one of those times that me, Charlie, is not willing to bet against the crowd, because I think the downside risks outweight the upside gains, even setting aside the impact war is going to have on bond prices via increased inflation and heightened political instabilities. (Waging war on Iraq is not a good thing for our futures, their futures, or those of both of our children's future. Everyone is going to lose, except the arms dealers, the banks, and the news stations.) A separate issue. I suspect CD's as an investment vehicle are currently more expensive than fair value measures would suggest. In other words, their buyers aren't being adequately compensated for the relative illiquidity and relative tax inefficiency of the instrument more than is usually the case --i.e., their usual buyers are the financially timid/inexperienced and the banks, etc. know that and exploit and capitalize on it to their own advantage--, but I'll confess that I haven't yet developed the argument fully enough to go public with it, because I'm trying to set up to trade stocks short term while I wait out the bond market. Charlie
What about the "muddle along" scenario, with the economy struggling but no significant inflation or deflation.....interest rates would remain in a range not much different from where they are presently....basically investors would end up earning the coupon(or dividend).
I think that the Fed Funds rate is so ridiculously low that I think long-term bond buyers feel it can't stay that way long so the 10-yr bond remains near its long-term average. But I do find it kind weird that the 10-yr Treasury has been bought down. The return on the 5-yr note is not that unusual either. We have one bought several years ago earning the same interest to maturity as you see right now. The spread between the Fed Funds rate and the longer notes and bonds is excessive.brucedoe
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