Bonds in a rising interest environment

Bonds in a rising interest environment

The general rule of thumb with bonds is prices tend to go down as interest rates rise. Of course with any theory there are exceptions, however, the reasoning behind it is reasonably straight forward. It helps to understand some bond basics.

A bond is essentially a loan you make to an entity like a government or corporation in return for interest. You can sell a bond, like any other security. How much you can sell your bond for is determined by how desirable the interest rate of it is compared to others on the market.

For example:

If you own a bond that is paying 5% and new bonds being issued with the same term are paying 6%, then your old bond may be worth less to investors than the new ones and thus their price goes down.

Longer term bonds tend to feel the effects of interest rates before shorter term bonds. Bond investors often choose to buy shorter term bonds instead of longer term bonds as pressure from rising interest rates affects the bond market.

How are bonds doing now?

Over the past couple of weeks, long term bond prices have fallen a bit, likely due to rising interest rates. As a result, in a few of our models we have shifted to some shorter bond positions. So far theory and reality are relatively close on this one. But remember, the inverse relationship between bond prices and interest rates is a rule of thumb and not an absolute.

Read more on Investopedia about bonds and interest rates: Here