After a fairly strong start to 2015 for bond market returns, interest rates have seemed to settle in lately. It’s possible that the bond market is beginning to price in a Fed Funds rate increase sometime in the near future. The chart above is a one year daily chart of the 10 year treasury interest rate index (TNX). The 10 year interest rate is close to turning positive for the year to date after being down at one point by 24%.
A measured move target comes into play at 24.50 with the year to date break even and March highs as potential deterrents. This is equated by taking the length of the rally off the February lows to March highs and adding that amount to the lows that were formed in April. It is important to note that this index is 10x the actual interest rate. So a target of 24.50 on TNX, would equate to a yield of 2.45%.
Why is this important to bond investors? I must preface that any short term movements have little if any importance to investors. However for educational purposes this “Bond see-saw” (as I’ve heard it explained as) means when interest rates rise, the market price of bond holdings decline (and vice-versa).
So let’s say for example you purchase a bond that pays 2% in interest annually. If after your purchase, rates drop to 1%, all of a sudden your bond that pays you 2% interest will look very attractive. The attractive rate will increase demand and in turn the market price of your bond will increase in market value.
Now let’s say that after purchasing your 2% bond, rates increase to 4%. In this case someone would look at your bond paying 2% and ask why they should purchase your bond when they can buy a new bond that pays them 4%. This decrease in demand will cause the market value to drop.
The consensus has suggested that rates will rise soon, the problem here is that they have been saying this for years. Interest rates will eventual move higher but no one knows the timing with any certainty.
