Bonds have a unique relationship with interest rates. The chart below shows what happens when there is an increase in interest rates.
After the stock market crash of 2008, the Federal Reserve, in an effort to stimulate the economy, reduced the cost of borrowing money by lowering interest rates to zero. We have been at historic lows in interest rates since 2009. An interest rate increase of 1% will cause a 10 year (duration) U.S. Treasury bond to drop -10% in value. There have been three interest rate increases the past few years:
- 0.25% Increase December 16, 2015
- 0.25% Increase December 14, 2016
- 0.25% Increase March 15, 2017
The long-term bull market in bonds may be coming to an end. This does not mean an investor should abandon owning bonds, rather, it is important investors understand ways to protect themselves by making adjustment to the types of bonds they own. Several things to consider when interest rates are rising: (1) own bonds with higher coupon rates (2) own shorter duration bonds (3) consider floating rate funds and (4) diversify against rising interest rates in the U.S. buy owning global bonds.