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It has been a long wait but the best news is we do not have to rely on someone else to buy our long-term bond positions for us to realize our investment goals. We have no long-term bond positions.

Bond Interest Rates Jump…Finally!

June 22nd, 2015 by Kurt L. Smith
  • Bonds are grabbing the headlines again and not in a good way.  Long-term interest rates worldwide have jumped about one full percentage point, sending longer-term bond prices down across the board.  Why this is the case is not important; the fact that bond values are evaporating is important.

    European bond yields that were near zero in April moved to near one percent in early June.  US Treasury ten year notes were near 1.60% in February; 2.50% in June.  Thirty year treasury bonds were near 2.20% in February and 3.20% in June.  All of this price and yield volatility occurred in a matter of weeks.  Price-wise this means bond prices are down about twenty percent on the longest US Treasuries and down about eight percent on ten year maturities.

    Obviously holders of these securities have seen the values on their statements change.  The bigger takeaway is how price/yield movements on these bellwether bonds has a widespread effect on longer-term fixed income securities in general.

    This is the price move I expected to occur and I believe will be but one of many as interest rates move higher.  For bond investors who have long waited for greater income, this move is a welcome relief.  The trick of course is to have a short, liquid portfolio that is able to take advantage of the higher interest rates without losing price value in the meanwhile.  Investors owning longer-term bonds or investments containing longer-term bonds will probably see a broad decline in price, leading to a substantial impact in value, in my opinion.

    Explaining why interest rates are rising is but a waste of time.  I am sure some say interest rates are rising because inflation is “just around the corner.”  This line of thinking has been a pipe dream of the Federal Reserve as well as all of those who believe in the omnipotence of the Fed.  No we will not see inflation rise.  We will see inflation continue to fall as the Federal Reserve is powerless (and has been powerless) to create inflation.

    Others say interest rates are rising because the growth we are expecting will soon be here.  Again, this is another Fed pipe dream with many adherents that continue to preach that growth will arrive…next quarter.  Growth isn’t arriving next quarter, though I am sure some will probably get out of their under-performing bond investments so that they can be (even) more all-in with stocks.

    Interest rates are also not moving because the US Dollar has moved.  Interest rates are moving world-wide, seemingly all at the same time and here recently even at the same rate (up one percent).

    My point is that interest rates move, period.  And when interest rates move in an upward direction as they have recently, values evaporate.  No one needed to sell.  No one sold (much) at the top and made a lot of money while others bought (much) at the top either.  Yet values evaporated…quickly.  This is how bond and stock markets work.  Value is marked each day, but value can always quickly evaporate if you happen to own the wrong bond or stock.

    This recent move in longer-term interest rates is but a precursor of the new trend.  Someday long-term bonds may once again be worthwhile to own, but I believe that day is a long, long way away.  We have enjoyed the benefits of a bond market trending towards higher prices for many years.  We are correcting that trend now by moving in the other direction, probably for many years as well.

    Our strategy remains intact as we saw the post-crisis bond market rally as the end of something rather than the new age of low rates forever.  I know few were in my camp over the past few years as almost every investor bit hard on the idea that low interest rates will be with us forever.  It has been a long wait but the best news is we do not have to rely on someone else to buy our long-term bond positions for us to realize our investment goals.  We have no long-term bond positions.

    On the other hand, think about all the trillions of dollars invested in bonds, many in longer-term securities.  Whether they forecasted the recent move or even put on a trade or two, in the scheme of things it does not matter.  At the end of the day PIMCO still has trillions invested in bonds that they will not sell or won’t sell.  Thinking about this, I certainly see why Bill Gross might want to leave and swap trillions for millions.

    I believe in our strategy and I believe our strategy is sound for the long run.  We practice it in good times and bad and we are fortunate that the municipal bond market provides us with tens of thousands of unique investment opportunities upon which to select.  Does the trend change towards rising interest rates change our approach?  No.  I have been a believer that the trend would change for many years.  Credit quality and short maturities are the starting points for our selection process.

    Lamar Independent School District, TX Refunding

    Moody’s Aaa (Aa2 Underlying) S&P: AAA (AA Underlying)

    Permanent School Fund Guaranteed

    Due 2/15 Dated 7/1/15 Maturity: 2/15/2048

    Sale Amount: $213,170,000

    YEAR MATURITY COUPON YTM*
    3 2018 5.00% 1.07%
    4 2019 5.00% 1.34%
    5 2020 5.00% 1.57%
    6 2021 5.00% 1.85%
    7 2022 5.00% 2.06%
    8 2023 3.50% 2.21%
    8 2023 5.00% 2.21%
    9 2024 5.00% 2.38%
    10 2025 5.00% 2.50%
    11 2026** 5.00% 2.63%
    12 2027** 5.00% 2.73%
    13 2028** 5.00% 2.84%
    14 2029** 5.00% 2.93%
    15 2030** 5.00% 3.00%
    16 2031** 5.00% 3.06%
    17 2032** 4.00% 3.51%
    18 2033** 4.00% 3.56%
    19 2034** 4.00% 3.60%
    20 2035** 4.00% 3.64%
    21 2036** 5.00% 3.26%
    22 2037** 5.00% 3.30%
    23 2038** 5.00% 3.34%
    24 2039** 5.00% 3.40%
    25 2040** 5.00% 3.43%
    29 2044* 5.00% 3.49%
    30 2045** 4.00% 3.90%
    33 2048** 4.00% 4.00%

      *Yield to Worst (Call or Maturity) **Par Call: 2/15/2025

    Source: Bloomberg

    This is an example of a new issue priced the week of 6/15/15

    Prices, yields and availability subject to change

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