Fed Rate Hikes & Bond Prices

After several interest-rate hikes this year, U.S. bond prices are looking for support and so far they have found it.

The iShares 7-10 Year Treasury ETF (IEF) closed today at $105.40.  Since June, $104.75 has provided price support.  Looking back to the start of 2016, a price of $101.50 has held ground.  The average yield* for this bond ETF is currently reported to be 2.36%.

Looking at interest rate sensitivity, the effective duration on IEF is 7.5.  This tells us it might only take a 50-basis point rate hike to move the price of IEF below $101, a real possibility next year.  Durations change and the surprising bond rally, along with stocks during most of 2017, may mean bond investors will be giving up a bit more if rates continue to rise.

With the Fed Funds rate already at 1.5%, the Fed may come up against the rate they are reluctant to cross, 2%.  It will be interesting to see how new Fed Chair, Jerome Powell, approaches rates next year.  It is highly likely the Fed is concerned bond price sensitivity (duration) may go up in 2018; something bond investors should keep in mind.  If you want to adjust your bond portfolio interest-rate sensitivity, now may be the time to do it.

There are a multitude of reason why the Fed needs to be more careful raising rates going forward; government-debt funding is at the top of the list.  And let’s not forget, the Fed has just started unwinding a balance sheet with billions in bonds.  There is no doubt Mr. Powell will have his hands full trying to appease the inflation hawks while selling bonds if the economy continues to grow.  It looks like next year could be very different for the bond market.

Here’s a quick look at where other bond ETF prices are trading.  As the charts below show, most of the bond market has taken this years’ rate hikes in stride.

Aggregate U.S. Bond, Average Yield* 2.68%

Corporate Bonds, Average Yield* 3.39%

High-Yield (Junk Bonds), Average Yield*  5.54%

Municipal Bonds, Average Yield* 2.16% (Tax Equivalent of 3.32% at 35% Rate)

* Average yield data provided by Blackrock at www.ishares.com.

Posted in Central Banks, Credit Markets, Dightman Capital, Interest Rates.

Brian Dightman