Back to the Future – When Interest Rates Rise

Back to the Future – When Interest Rates Rise

The long bull market in bonds will eventually come to an end. Interest rates have been falling from their peak in 1981 to lows set in 2012.[1] That is over 30 years. Ultimately, rates will rise as the economy continues to strengthen. Coming off the lowest interest rates in 50 years, it is educational to look back at one of our worst bond markets, the late ’70’s. From the end of 1976 to the autumn of 1981, the yield on the 10-year treasury jumped from 7% to over 15% (see chart). The prices of intermediate term treasuries (average maturities of around 5 years) fell by more than 25% while longer maturities fell much more.1

With the 10-year treasury yield sitting at 2.5% as of August 2014, many anticipate a move to 4% in the near future. Let’s assume you purchased a 10-year treasury bond today at face value of $10,000 paying 2.5%. If rates rose to 4% tomorrow, the bond would theoretically decline by approximately 12.25% and sell for $8,775 [$10,000 – $10,000(.1225)]. The lower price provides the buyer with a 4% rate of return if he holds to maturity. If you simply keep the bond you would continue to collect the 2.5% or $250 per year and get the full $10,000 back at maturity.
Even if yields rise in the next 12 months and bonds suffer losses, total returns should turn positive within a few years if rates do not rise much above 4%. The longer you hold, the more you benefit from the income. That said, today’s low yields suggest that returns will be small by historical standards and that income will provide less of a cushion against price declines than before so it is important to manage bond maturities based on your needs for income and capital by buying maturities that match your needs. Now is a good time to have your advisor review your bond portfolio with those needs in mind.

The Menashe Morley Group: David Menashe is a Senior Vice President and Wealth Management Advisor, and Bruce Morley is a First Vice President and Wealth Management Advisor and John Naviaux is a Financial Advisor for Merrill Lynch, Pierce, Fenner & Smith Incorporated, a registered broker-dealer, Member SIPC, and a wholly owned subsidiary of Bank of America Corporation. Investment products are not FDIC insured, are not bank guaranteed, may lose value. The Menashe Morley Group can be reached at 858-381-8113.

© 2014 Bank of America Corporation. All rights reserved. | ARQ86JQP | 8/2014

[1] BofA Merrill Lynch Global Research, “It’s All about the Income”, July 1, 2014.

Photo by Andy Templeton