Why Have Bond Markets Been So Volatile?

Interest rates have risen significantly in 2013 with the five-year Treasury rate up 0.67 percent through the end of the second quarter. To put this increase in perspective, from the end of 1962 through 2012, there were 17 other years when interest rates increased this much or more over an entire year. The recent increase in interest rates has led to questions about why they have risen so substantially and what the implications are.

The U.S.’s central bank, the Federal Reserve, continues to be the dominant influence on interest rates, and it has aggressively acted to keep them down since 2008–2009. The Federal Reserve has done so by keeping the federal funds rate low and purchasing enormous quantities of bonds. The thinking was that lower interest rates would help improve the economy and bring down unemployment. While no one would say the economy is back to full health, the Federal Reserve has indicated it believes it will be healthy enough in the near future to begin slowing down portions of its policy efforts.

On June 19, Chairman Ben Bernanke indicated that he expects the Federal Reserve will begin to reduce the amount of bond purchases later this year and end them by next year. This is generally believed to be the reason interest rates increased during the second quarter. It is important to keep in mind that the Federal Reserve still expects to keep the federal funds rate (which is the primary way it influences interest rates) low for some time to come.

While no one knows whether interest rates will move higher or fall again, the recent increases are actually good news for our institutional clients with long time horizons and relatively short- and intermediate-term bond holdings. Although the value of those types of holdings has generally gone down in 2013, the long-term returns investors can now expect from bonds are higher than they were at the start of the year. Regardless of which direction interest rates move, institutions and non-profit organizations are better served when they keep an emphasis on short- and intermediate-term bonds and bond funds with high credit quality in the fixed income portion of their portfolio.

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2013, The BAM ALLIANCE

 

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