Caught Between a Rock and a Hard Place - Understanding the Relationship Between Bond Prices & Interest Rates |  WT Wealth Management White Paper

News Alert! Interest rates will increase in the coming months and years.

There, I said it. After the Financial Crisis of 2008 it took the Federal Reserve SEVEN years (Dec 2008 to Dec 2015) to make their first increase to the Federal Funds Rate (FFR), moving first from a range of 0.00-0.25 to 0.25-0.50. Over the next 3 years -- through December 2018 – the Fed managed to increase the FFR to a range of 2.25-2.50 through 9 measured rate increases. This process is commonly referred to as rate normalization.

For historical perspective the FFR from 1994 to 2001 never was below 4.75% and reached 6.00% on several occasions.

Now today, after the Covid pandemic, when the Fed slashed rates to 0.00-0.25 yet again in March of 2020, we find ourselves at another all-time low, looking ahead to next summer when most economists believe the Federal Reserve will once again begin the long campaign of rate normalization. As inflation pressures have recently increased, most economists are now predicting the Fed will move even more quickly than was thought just 90 days ago (the increased tapering announcement is a precursor to such moves).

Forward Markets: The Projected Path of Fed Rate Hikes - Chicago Mercantile Exchange
Source: Chicago Mercentile Exchange

What Is the FFR?

The term Federal Funds Rate, or FFR, refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. The FOMC is responsible to set the target federal funds rate as part of its monetary policy. Monetary policy is used to help promote, control and even at times constrict economic growth. The FFR is the only part of the yield curve that the Federal Reserve directly controls. 1

As the yield on the short end of the interest rate curve (i.e., the overnight rate) is pushed higher the maturities behind it (i.e., 3-month, 6-month, 2-year, 10-year, 30-year, etc.) also increase in yield. Generally, the longer an investor is willing to wait for a bond to mature, the more they are rewarded with increased yield. This is not unlike any other fundamental of investing where you are rewarded for risk. And yes, going farther out in years on the curve is taking on additional risk as you are waiting longer for your money.

Yield vs Maturity

There is a common perception among many investors that bonds represent the safer part of a balanced portfolio and are less risky than stocks. While bonds have historically been less volatile than stocks over the long term, they are not without risk. Treasury bonds (as well as other types of fixed income investments) are sensitive to interest rate risk, which refers to the possibility that a rise in interest rates will cause the value of previously issued bonds to decline. Bond prices and interest rates move in opposite directions. When interest rates fall, the value of a bond previously issued at a higher interest rate will rise. When interest rates rise, the valued of a bond previously issued at a lower interest rate will fall.

If Interest Rates Rise vs. If Interest Rates Fall
Source: Everything You Need to Know About Bonds –

If rates rise and you sell a bond held in your portfolio prior to its maturity date (the date on which your investment principal is scheduled to be returned to you), you could end up receiving less in exchange than what you originally paid for your bond. Similarly, if you own a bond fund or bond exchange-traded fund (ETF), its net asset value will decline if interest rates rise. The degree to which values will fluctuate depends on several factors, including the maturity date and coupon rate on the bond or the bonds held by the fund or ETF.

Using a bond's duration to gauge interest rate risk

Investment professionals closely examine a bond's "duration" – a measure that combines several bond characteristics (such as maturity date, coupon payments, etc.) into a single number that indicates how sensitive a bond's price will likely be to interest rate changes. Generally, bonds with long maturities and low coupons are more sensitive to a change in market interest rates and thus are more volatile in a changing rate environment. Conversely, bonds with shorter maturity dates or higher coupons will be less sensitive to changing rates and thus are less volatile in a changing rate environment.

The chart below shows how a bond with a 5% annual coupon that matures in 10 years (yellow bar) would fall more in price as interest rates rise than a bond with that same 5% coupon but only 6 months left to maturity (blue bar). Why is this so? Because bonds with shorter maturities return investors' principal more quickly than long-term bonds do. Therefore, they carry less long-term risk because the principal is returned, and can be reinvested, earlier.

Price Drop vs Rise in Interest Rate
Source: Learning Center

Of course, duration works both ways. If interest rates were to fall, the value of a bond with a longer duration would rise more than a bond with a shorter duration. Therefore, in our example above, if interest rates were to fall by 1%, the 10-year bond would rise in value by approximately 9%. If rates were to fall 2%, the bond's value would also rise by approximately twice as much (18%). 2


While higher interest rates will be great news for retirees and any less risk tolerant investor in a more diversified 70/30, 60/40 or 50/50 portfolio, it can be a rough and bumpy road as the Fed works to increase rates. Increasing rates will result in declining prices for the safe, risk off portion of an investor's portfolio. This occurs at the same time that equities, the risk on portion, are also struggling to effectively compete against the now higher interest rates. The result?. . . investors may feel caught between a rock and a hard place as the Fed tightens economic conditions.

The good news is that these difficult rate hiking campaigns tend to normalize over several quarters – a relatively short time period – and the equity markets rediscover their traditional direction upward and to the right.

At WT Wealth Management it's our job to keep you informed and that's the purpose of this paper. While we do believe interest rate normalization is ultimately healthy for the economy, it can be uncomfortable getting there. Please reach out to your advisor if you would like to discuss more. We're happy to help.

  1. Federal funds rate

  2. Duration: Understanding the relationship between bond prices and interest rates


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Any opinions expressed on this website are the opinions of WT Wealth Management and its associates only. Material listed on this website is neither an offer to buy or sell securities nor should it be interpreted as personal financial advice. You should always seek out the advice of a qualified investment professional before deciding to invest. Investing in stocks, bonds, mutual funds and ETF’s carry certain specific risks and part or all of your account value can be lost.

At WT Wealth Management we strongly suggest having a personal financial plan in place before making any investment decisions including understanding your personal risk tolerance and having clearly outlined investment objectives.

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WT Wealth Management is an SEC registered investment adviser, with in excess of $100 million in assets under management (AUM) with offices in Flagstaff, Scottsdale, Sedona and Tucson, AZ along with Jackson Hole, WY and Las Vegas, NV. WT Wealth Management is a manager of Separately Managed Accounts (SMAs). With SMAs, performance can vary widely from investor to investor as each portfolio is individually constructed and managed. Asset allocation weightings are determined based on a wide array of economic and market conditions the day the funds are invested. In an SMA, each investor may own individual Exchange Traded Funds (ETFs), individual equities or mutual funds. As the manager we have the freedom and flexibility to tailor the portfolio to address an individual investor's personal risk tolerance and investment objectives – thus making the account “separate” and distinct from all others we manage. An investment with WT Wealth Management is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Any opinions expressed are the opinions of WT Wealth Management and its associates only. Information offered is neither an offer to buy or sell securities nor should it be interpreted as personal financial advice. Always seek out the advice of a qualified investment professional before deciding to invest. Investing in stocks, bonds, mutual funds and ETFs carries certain specific risks and part or all of an account's value can be lost. In addition to the normal risks associated with investing, narrowly focused investments, investments in smaller companies, sector and/or thematic ETFs and investments in single countries typically exhibit higher volatility. International, Emerging Market and Frontier Market ETFs, mutual funds and individual securities may involve risk of capital loss from unfavorable fluctuations in currency values, from differences in generally accepted accounting principles or from economic or political instability that other nations experience. Individual bonds, bond mutual funds and bond ETFs will typically decrease in value as interest rates rise. A portion of a municipal bond fund's income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains (short and long-term), if any, are subject to capital gains tax. Diversification and asset allocation may not protect against market risk or investment losses. At WT Wealth Management, we strongly suggest having a personal financial plan in place before making any investment decisions including understanding personal risk tolerance, having clearly outlined investment objectives and a clearly defined investment time horizon. WT Wealth Management may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. Individualized responses to persons that involve either the effecting of transactions in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption. WT Wealth Management's website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Accordingly, the publication of WT Wealth Management's website should not be construed by any consumer and/or prospective client as WT Wealth Management's solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the internet. Any subsequent, direct communication by WT Wealth Management with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A copy of WT Wealth Management's current written disclosure statement discussing WT Wealth Management's registrations, business operations, services, and fees is available at the SEC's investment adviser public information website (www. or from WT Wealth Management directly. WT Wealth Management does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to WT Wealth Management's web site or incorporated therein, and takes no responsibility therefor. All such information is provided solely for convenience purposes and all users thereof should be guided accordingly.

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