Author Topic: Bonds !!!  (Read 3188 times)

vand

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Re: Bonds !!!
« Reply #50 on: February 20, 2021, 02:49:29 AM »
Some good discussion above.

The great problem that I see is is that as debt across public, corporate and household sectors all ballooned last year, so if we go back to the same level of interest rates as before, the overall cost of maintaining (never mind repaying) the debt will be proportionally greater.  The economy gears itself on more and more borrowing as rates go lower and lower, and unless debt is actually repaid then it traps you into an economy that cannot withstand higher rates because of its indebtedness.

Last time the stock market was this expensive the US was fundamentally in pretty good shape, with debt/GDP below 40% and coming off a couple of years where the Clinton administration actually managed to run small budget surpluses.  Today debt/GDP stands at 140%

When your debt is 40% then it costs you 2% of GDP to service your debt at 5% interest rates - this is traditionall the sort of level that developed economies have been pegged at. By contrast when your debt/GDP is 140% then you need interest rates to be 1.45% to keep your debt servicing costs below 2% of GDP. When rates start going higher then the numbers go south quite quickly.

And the US hasn't even managed to run anything resembling a balance budget since Clinton - it needs to issue more debt just to pay off existing interest, and the deficit is only increasing.

So maybe, as well as signalling rising inflation expectations (which I agree with), the move higher in rates is the market also indicating that we are beginning to explore the limits of what investors will allow governments to borrow without demanding a higher risk premium.

MustacheAndaHalf

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Re: Bonds !!!
« Reply #51 on: February 20, 2021, 03:26:24 AM »
Bonds generally suffer under rising interest rates
Bonds always suffer under rising interest rates everything else being equal (i.e. credit spreads unchanged)
As an investment, the bond's yield may be more significant than the capital loss caused by an interest rate increase.  The slower the interest rate increase, and shorter the term of the bond, the less likely interest rates will show an impact.


since the latest bonds have better yields than older bonds.
Nope, the yields tend to be pretty similar for similar maturities for the same issuer. Older bonds have higher coupons, but since they have that you also have to pay a lot more to buy them so if you buy an old treasury paying a 5% coupon your yield is much lower as it will trade at a premium.
Rising interest rates mean new bonds have higher coupons than old bonds.  How can rising interest rates mean "Older bonds have higher coupons"?

The new bonds have higher yields than the older bonds did.  I am comparing two points in time, like 6 months ago 30 year treasuries with today's treasuries.  When issued, the older bonds might yield 1.5%.  New bonds yield 2.0% because yields and interest rates are rising.  I agree the older bonds then adjust, by losing value until they are comparable to 2.0% yielding treasuries.

A person who just invested in treasuries has a better return than someone who invested a few months ago at lower yields.  The process of making the bonds comparable causes the older bonds to lose value.

MustacheAndaHalf

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Re: Bonds !!!
« Reply #52 on: February 20, 2021, 03:44:19 AM »
According to the Federal Reserve Bank of St Louis ("FRED"), from Q1 2020 to Q2 2020 the U.S. went from 108% debt/GDP to 140%.  The last update I see is 127% for Q3 2020, but I expect the $1.9 trillion stimulus to have an impact when Q1 2021 numbers come out later this year.
https://fred.stlouisfed.org/series/GFDEGDQ188S

From 1991-2021 on that graph, the lowest level seems to be 54% debt/GDP right before the dot-com bubble burst.  Ranking a list of countries by debt/GDP puts the U.S. 6th worst in the list of 199 countries on wikipedia.  The #3, #4, #5 countries are Greece, Italy, Lebanon... so not good company to be in.
https://en.wikipedia.org/wiki/List_of_countries_by_public_debt

habanero

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Re: Bonds !!!
« Reply #53 on: February 20, 2021, 06:23:17 AM »
Rising interest rates mean new bonds have higher coupons than old bonds.  How can rising interest rates mean "Older bonds have higher coupons"?

Because interest rates have been much higher earlier despite the recent rise in rates. If you want to invest say around the 5ypoint in treasuries you can buy the most recently issued 5y note, you can buy a 30y bond issued 25 years ago, a 10y note issued 5 years ago and so on. Depending on exactly which bond you buy their coupons can differ a lot, but the yields will be pretty similar for a given remaining maturity as you will have to pay a steep premium for the high-coupon ones and you will get the lower-coupon ones at a discount. As these bonds have different characteristics with different duration the sensitivity to interest rates will differ.

I don't think we really disagree on anything, just how long ago "earlier" is.




tooqk4u22

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Re: Bonds !!!
« Reply #54 on: February 20, 2021, 06:38:16 AM »

When your debt is 40% then it costs you 2% of GDP to service your debt at 5% interest rates - this is traditionall the sort of level that developed economies have been pegged at. By contrast when your debt/GDP is 140% then you need interest rates to be 1.45% to keep your debt servicing costs below 2% of GDP. When rates start going higher then the numbers go south quite quickly.


This is a notable point, especially considering that the federal government has mostly been issuing t-bills and bonds with shorter maturities - and that is the ONLY reason why the Fed and Treasury can get up there and say see  -  a shit ton of money was put in the system and our interest expense actually went down!  Sure it does, when all is issued and maturities are refinanced with 364 day notes at historically low rates.   Very little 30 years issued because we can't afford it. 

MustacheAndaHalf

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Re: Bonds !!!
« Reply #55 on: February 20, 2021, 07:06:19 AM »
habanero - I see why we're talking past each other.  You're talking about actual interest rates from 2019 vs now, while I'm talking about a time frame where interest rates start low and go higher.

Most people buy bond funds, instead of bonds, and I think you'd agree bond funds are impacted to the inverse of their duration.  Vanguard's Total Bond ETF (BND) has a duration of 6.6 years, so a 0.5% increase in yields (across all maturities) should cause a -3.3% change in BND's value.  They take a capital loss when interest rates rise.
https://investor.vanguard.com/etf/profile/portfolio/bnd


tooqk4u22 - Where can I learn more about the distribution of treasuries issued in 2020?  I guess it makes sense 30 year treasuries weren't popular when they paid around 1%.

ChpBstrd

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Re: Bonds !!!
« Reply #56 on: February 20, 2021, 08:07:37 AM »

When your debt is 40% then it costs you 2% of GDP to service your debt at 5% interest rates - this is traditionall the sort of level that developed economies have been pegged at. By contrast when your debt/GDP is 140% then you need interest rates to be 1.45% to keep your debt servicing costs below 2% of GDP. When rates start going higher then the numbers go south quite quickly.

It’s a given that higher interest rates would demolish the US economy. There’s also a case to be made that higher rates would feed upon themselves as investments in the US economy would get riskier and riskier as interest rates went up, causing investors to demand higher risk premiums, which cause higher interest rates. A scenario previously visited by Greece, Italy, and Argentina would ensue.

The question then, is whether the US government can prevent this outcome by keeping rates low indefinitely. So far, the Fed has been winning, and in the process building a huge war chest of assets that can be sold off on short notice to quash any idea of inflation. Investors say “don’t fight the Fed”. I bet the Fed will keep on winning at its new unofficial mandate to keep rates low.

Permanently low rates in the US set the stage for China or India to open their economies, float the world’s new reserve currencies, and capture a greater share of worldwide investment flows. Imagine if you could borrow USD for 2% and invest in the digital Yuan at a Chinese bank paying 5%. This would be the reverse story of how the US became so prosperous after WW2, wouldn’t it?

IDK if any other countries are actually in a position, politically, to capitalize on the opportunity, but it is there.

MustacheAndaHalf

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Re: Bonds !!!
« Reply #57 on: February 20, 2021, 09:44:17 PM »
It’s a given that higher interest rates would demolish the US economy. There’s also a case to be made that higher rates would feed upon themselves as investments in the US economy would get riskier and riskier as interest rates went up, causing investors to demand higher risk premiums, which cause higher interest rates. A scenario previously visited by Greece, Italy, and Argentina would ensue.
And the U.S., back in the 1980s, which reinforces your point:
https://en.wikipedia.org/wiki/Early_1980s_recession
"The sharp rise in oil prices pushed the already high rates of inflation in several major advanced countries to new double-digit highs, with countries such as the United States, Canada, West Germany, Italy, the United Kingdom and Japan tightening their monetary policies by increasing interest rates in order control the inflation"
"Most of these countries experienced stagflation, a situation of both high interest rates and high unemployment rates."


I bet the Fed will keep on winning at its new unofficial mandate to keep rates low.

I think the Fed plans to let inflation run higher than it's 2% goal for a time, so that average inflation hits it's goal.  I don't know if they'll succeed, but:

https://www.cnbc.com/2021/01/27/fed-decision-january-2021-rates-unchanged.html
"In recent months, officials have made their commitment to low rates even more aggressive, vowing not to start hiking even if inflation gets close to or slightly exceeds the central bank’s 2% target."

vand

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Re: Bonds !!!
« Reply #58 on: February 21, 2021, 09:23:37 AM »

When your debt is 40% then it costs you 2% of GDP to service your debt at 5% interest rates - this is traditionall the sort of level that developed economies have been pegged at. By contrast when your debt/GDP is 140% then you need interest rates to be 1.45% to keep your debt servicing costs below 2% of GDP. When rates start going higher then the numbers go south quite quickly.

It’s a given that higher interest rates would demolish the US economy. There’s also a case to be made that higher rates would feed upon themselves as investments in the US economy would get riskier and riskier as interest rates went up, causing investors to demand higher risk premiums, which cause higher interest rates. A scenario previously visited by Greece, Italy, and Argentina would ensue.

The question then, is whether the US government can prevent this outcome by keeping rates low indefinitely. So far, the Fed has been winning, and in the process building a huge war chest of assets that can be sold off on short notice to quash any idea of inflation. Investors say “don’t fight the Fed”. I bet the Fed will keep on winning at its new unofficial mandate to keep rates low.

Permanently low rates in the US set the stage for China or India to open their economies, float the world’s new reserve currencies, and capture a greater share of worldwide investment flows. Imagine if you could borrow USD for 2% and invest in the digital Yuan at a Chinese bank paying 5%. This would be the reverse story of how the US became so prosperous after WW2, wouldn’t it?

IDK if any other countries are actually in a position, politically, to capitalize on the opportunity, but it is there.

Absolutely agreed with this.

So far Fed policy has been so successful because the lack of inflation allows them to print as much currency as they need to in order to support the economy and financial system.  However if and when inflation starts to rear its head this removes their favourite tools, and they are forced to tighten monetary policy in order to fight inflation.  There can be a reflexive loop as lower/negative growth means investors have less faith in the government's ability to meet its obligations, so they are less willing to buy its debt, making it more expensive to borrow, further hindering growth, which further eroding investors' faith, so they demand even higher rates of return etc.

Again, there is really nothing new here and we've seen it before, but certainly not for a very long time in the US, such that most people will have no memory of the last time the Fed was backed into this corner.

vand

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Re: Bonds !!!
« Reply #59 on: February 22, 2021, 06:54:25 AM »

For context, this time last year it was:
10y: 1.56%
30y: 2.01%

Of course, by then the early warnings about Covid were starting to be digested, so looking at Jan 2, 2020 rates were:
10y: 1.88%
30y: 2.33%


The yield curve is is steepening, so one way to play it could be to buy banks and financial stocks. Indeed the sector has seen some pretty good performance in the last few months, and I notice that today they're doing quite well comparatively when the rest of the broader market is down.  This might be one of the less-dumb ways of "owning" inflation.

CrankAddict

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Re: Bonds !!!
« Reply #60 on: February 22, 2021, 01:15:21 PM »
This thread is making my head hurt.  So as the representative idiot here, I've plodded along for 20+ years with this crude understanding that "bonds are safe but aren't going to wow you with returns" and "stocks have potential to make more money but it's going to be a rocky ride".  You can go to Vanguard today and in their investing advice page it shows "conservative" = 70% bond, 30% stock,  "moderate" = 50/50 and "aggressive" = 70% stock, 30% bond.  This is inline with what I understood.  As a result for quite some time I was 70/30 VTSAX/VBTLX and then in December I went to 55/45 over a general feeling of uncertainly and lack of faith in half a dozens aspects of our national and global situation.  I'm currently trying to decide what AA to move to again for the longer term but when I read this thread it basically sounds like the opposite of all I thought I knew.  It sounds like bonds should be named "bombs" and if I really wanted to be conservative I'd get rid of these things asap. 

Do these bond risks apply as much to bond funds such as VBTLX?  My (limited) understanding is that if I bought myself actual bonds today and then tomorrow interest rates increase, my bonds will be worth less because tomorrow's bonds will pay a higher return to match higher rates.  My bonds from today will be less appealing.  But with bond funds, how does this work?  There's only 1 price for VBTLX.  How can that be?  If I bought it 5 years ago wouldn't it be holding bonds that have a different yield than if I bought it today?  I must be missing something fundamental.  And to be honest I'm not sure I need to understand all the mechanics, but more just the high level question of whether a bond fund can still be used the way I've always thought it could be.
« Last Edit: February 22, 2021, 01:55:54 PM by CrankAddict »

ChpBstrd

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Re: Bonds !!!
« Reply #61 on: February 22, 2021, 01:57:15 PM »
This thread is making my head hurt.  So as the representative idiot here, I've plodded along for 20+ years with this crude understanding that "bonds are safe but aren't going to wow you with returns" and "stocks have potential to make more money but it's going to be a rocky ride".  You can go to Vanguard today and in their investing advice page it shows "conservative" = 70% bond, 30% stock,  "moderate" = 50/50 and "aggressive" = 70% stock, 30% bond.  This is inline with what I understood.  As a result for quite some time I was 70/30 VTSAX/VBTLX and then in December I went to 55/45 over a general feeling of uncertainly and lack of faith in half a dozens aspects of our national and global situation.  I'm currently trying to decide what AA to move to again for the longer term but when I read this thread it basically sounds like the opposite of all I thought I knew.  It sounds like bonds should be named "bombs" and if I really wanted to be conservative I'd get rid of these things asap. 

Do these bond risks apply as much to bond funds such as VBTLX?  My (limited) understanding is that if I bought myself actual bonds today and then tomorrow interest rates increase, my bonds will be worth less because tomorrow's bonds will pay a higher yield to match higher rates.  My bonds from today will be less appealing.  But with bond funds, how does this work?  There's only 1 price for VBTLX.  How can that be?  If I bought it 5 years ago wouldn't it be holding bonds that have a different yield than if I bought it today?  I must be missing something fundamental.  And to be honest I'm not sure I need to understand all the mechanics, but more just the high level question of whether a bond fund can still be used the way I've always thought it could be.

Yes, bonds could tank in a surprising way if interest rates rise. That has always been the case, but the effect is magnified due to "bond convexity" which is to say bonds are more sensitive to interest rate changes at very low interest rates like we have now. You can create your own rough models in Excel using the PV function. Flip through different interest rates and durations to assess the potential for damage. That said, stocks will probably do worse than bonds in any inflationary scenario.

To really get low-risk, one must get into hedging strategies using options IMO.

Bond funds are constantly trading and churning their bonds, trying to maintain an average duration, interest rate sensitivity, ratings, or index exposure. Thus their performance will differ from a single bond, bought and held. The single bond is constantly changing its duration and interest rate sensitivity, and sometimes the rating changes too.


CrankAddict

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Re: Bonds !!!
« Reply #62 on: February 22, 2021, 03:51:10 PM »
Yes, bonds could tank in a surprising way if interest rates rise. That has always been the case, but the effect is magnified due to "bond convexity" which is to say bonds are more sensitive to interest rate changes at very low interest rates like we have now.

Didn't realize it was non-linear in some way, good to know.

Bond funds are constantly trading and churning their bonds, trying to maintain an average duration, interest rate sensitivity, ratings, or index exposure. Thus their performance will differ from a single bond, bought and held. The single bond is constantly changing its duration and interest rate sensitivity, and sometimes the rating changes too.

So am I wrong to conclude that bond funds are designed to be interest rate INsensitive as much as possible?

vand

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Re: Bonds !!!
« Reply #63 on: February 22, 2021, 04:11:04 PM »
https://www.blackrock.com/us/individual/education/understanding-duration

"As a general rule, for every 1% increase or decrease in interest rates, a bond's price will change approximately 1% in the opposite direction for every year of duration."

For reference, the TLT bond fund (20+yr maturity) has a duration of almost 19yrs, so a 1% change in long term rates would move the fund 19% in the other direction, and the US 30yr note has a duration of about 21yrs.

So you can see how sensitive long bond funds are to a rise in long term rates - they are certainly not "safe" if by safe you mean you can't lose real money (ie purchasing power) with them over either short or long holding periods. They are only considered safe in that theoretically the issuer has a printing press and so never needs to hard default on them.



ChpBstrd

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Re: Bonds !!!
« Reply #64 on: February 22, 2021, 08:40:02 PM »

So am I wrong to conclude that bond funds are designed to be interest rate INsensitive as much as possible?

Short durations have low sensitivity. Long durations have high sensitivity.

A short-duration fund like BSV will naturally be less sensitive to changes in interest rates than a long-duration fund like TLT. Long duration typically has a higher yield than low duration because investors must be compensated for the added risk.

Funds have to pick a duration to buy anything, and thus they have to pick an interest rate sensitivity. Some actively-managed funds might incorporate hedges against interest rate increases (swaps, futures, options...) but with today's yields so low, I doubt they have much to work with, because the cost of such hedges would have to come out of the already-puny yield.

vand

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Re: Bonds !!!
« Reply #65 on: February 23, 2021, 02:30:23 AM »
https://theirrelevantinvestor.com/2021/02/16/bonds-are-getting-crushed/

Good chart this, show how credit spreads are widening. This is good, to an extent, for financials.. and bad for high p/e bubble stocks.


ZROZ ouch:

MustacheAndaHalf

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Re: Bonds !!!
« Reply #66 on: February 23, 2021, 09:20:10 AM »
So am I wrong to conclude that bond funds are designed to be interest rate INsensitive as much as possible?

Vanguard long-term treasury bond fund had -9.37% performance year to date.  Their short-term treasury bond fund was just -0.16% year to date.
https://investor.vanguard.com/mutual-funds/profile/performance/vustx
https://investor.vanguard.com/mutual-funds/profile/performance/vfisx