Why interest rates are increasing and what could happen to bonds, stocks and the economy if rates returned to more normal levels.
In this episode you’ll learn:
- How nominal interest rates can be decomposed into subcomponents such as the real yield, inflation expectations and the term premium.
- What would need to happen to the subcomponents of interest rates for nominal yields to rise.
- How supply and demand for bonds impacts interest rates.
- How to invest in the face of rising interest rates.
- How private sector debt has changed.
Show Notes
Principles: Life and Work by Ray Dalio
Why Are Interest Rates So Low: Part 4 – Term Premiums – Ben Bernanke
U.S. Treasury Sales Are About To Double – Bloomberg
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Episode Summary – Has A Bond Bear Market Begun?
On this episode of Money For the Rest of Us, David Stein walks you through the complex idea of a bond bear market. He explains that a market consisting of losses of 20% or more are considered a bear market type loss and that this type of loss is possible even in the bond market. David states that “It’s important to understand what drives interest rates, how high they could get, and what the ramifications of that are.” Be sure to listen to this full episode to fully understand this idea and to hear some of David’s suggestions for investing in a rising interest rate environment.
When was the absolute low in interest rates and the beginning of the bond bear market?
After the Brexit vote, in early July 2016, ten-year treasury bonds were yielding 1.37%. Today, they’re yielding 2.85% with an annualized return over that period of approximately negative 4.5% annualized. Ray Dalio, the founder of the hedge fund Bridgewater Associates and author of “Principles,” explains, “A 1% rise in bond yields will produce the largest bear market in bonds that we have seen since 1980-1981.” Investors around the globe are asking big questions about what these changes in interest rates mean, and David does a great job of explaining the issues on this episode of Money For the Rest of Us.
The simplest way to dissect the complex idea of interest rates
With a discussion of the bond bear market comes many moving parts. David seeks to explain the concepts while utilizing the analogy of cutting an apple. An apple can be cut in many different ways, and each method uncovers a new way of looking at the apple and its pieces – in this case, interest rates. There are two main interest components that are discussed in this episode of Money For the Rest of Us: inflation expectations and real rates (i.e. your return after inflation.)
Analyzing how high interest rates could rise by decomposing the nominal yield into the expected path of future short-term interest rates and term premiums
Not only does David explain the idea behind a bear market on this episode of Money For the Rest of Us, he also examines nominal yields and how they can be dissected into the expected path of future short-term interest rates and term premiums. While the drivers behind climbing interest rates cannot always be observed directly, these two main factors shed light on just how high interest rates could climb in the coming years. Also, learn how the Federal Reserve estimates the path of short-term of interest rates and why term premiums are countercyclical and tend to rise when there is a great deal of investor uncertainty.
How do supply and demand factors impact these interest rate scenarios within a global market
As with many other industries, the reality of supply and demand impacts every aspect of the financial market. It is predicted that in 2018 the United States Treasury will have net new issue of $1.3 trillion in treasury bonds and the national debt will continue to rise. This new influx of debt will need to be purchased by the market, but the Federal Reserve is reducing the amount that it’s purchasing – their bond holdings will decrease by 10% over the next year. International buyers will become an even more important cog in the wheel, and David comprehensively explores the global supply and demand structure on this episode of Money For the Rest of Us. You also don’t want to miss his bear market investment suggestions, so be sure to listen.
Episode Chronology
[0:38] David poses the question for this episode, has the bond bear market begun?[3:59] When was the absolute bottom in interest rates and the beginning of the bond bear market?
[5:29] The simplest way to dissect interest rates into their subcomponents.
[7:41] How much higher could these rates get?
[15:02] The question is, in a bond bear market, how high could interest rates go?
[20:21] How global supply and demand could impact the bear market scenario
[22:48] What do we do about all of this?
[25:35] Why markets are becoming worried about these interest rate changes
