Understanding angst in the Fixed Income markets

by Wayne Ferbert on March 14th, 2013

This week, there was an excellent article in the Wall Street Journal about the potential impact of interest rate increases on the prices in the bond market. We all already know that the longer the duration and the higher the quality on your current fixed income holdings, the more price risk you carry if rates rise.

As a result, Treasuries are most at risk - especially the 10 year and beyond. These factors have, in part at least, driven some of the net fund flow growth to the High Yield fixed income category. These higher yields will be a little bit more price insulated in the event that rates rise. Of course, high yield will suffer also. The risk premium you want to get paid for being in higher risk bonds will become worse for the investor in high yield as rates go back up. There is no hiding in fixed income when rates go up.

The article in the WSJ is here if you want to read it.

Here are a few excerpts:

Figuring that the Federal Reserve won't be able to keep a lid on interest rates forever, large money managers such as BlackRock Inc., BLK +0.95% TCW Group Inc. and Pacific Investment Management Co. are getting ready for the day when rates take their first turn higher.
It isn't coming anytime soon, these investors say. But when it does, they worry, the ascent will be swift and steep.

The swift and steep commentary is where investors will worry. In addition:

The fear is that as expectations of rate increases mount, short-term investors will bolt for the exits as prices drop, causing wild price swings and amplifying losses. The last such exodus took place in 1994, when Fed rate increases triggered a wave of selling that left 30-year bond prices down almost 24% in a year.

Speaking of 1994, check out the chart from the WSJ article if you read it. The rise in rates in 1994 when the Fed started tightening was steep. So, remind yourself: the Fed is capable of such a move - even if many experts find it unlikely.

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