Since Federal Reserve Chairman Ben Bernanke announced the Fed’s intention to taper the bond-buying program, know as quantitative easing (QE), the bond market has seen record flows out of all bond asset classes.
No sector was spared.
What is happening?
The bond market is getting prepared to lose its biggest buyer—or at least it thinks so—and that really will be data dependent.
What happens when demand for low-interest-rate debt disappears? The price of low interest rates drops. It is a response to lower demand.
That part is relatively simple. What isn’t so simple is what else happens as interest rates rise. Volatility increases.
Source: Standard & Poor’s, Chicago Board Options Exchange Fact Set – ING Global Perspectives, June 2013 (see graph above).
But don’t throw out the baby with the bath water.
Here’s what you need to know:
- The adjustment will be turbulent. The price of bonds will fall as interest rates rise. Managing the duration of your bond holdings becomes increasingly important. Note that duration is the measure of the length of maturity and cash flows of bonds expressed in years, indicating the sensitivity to interest-rate changes.
- As the rates adjust upward, they will not go straight up. They will pull back at times if there is a rise in uncertainty, even as they move up longer-term. One of the reasons to have bonds is as a volatility control mechanism against stocks, which tend to be more risky and volatile.
- During sharp declines in the stock market, bonds usually rise. However, last month that did not happen—all asset classes trended together. Why? Partly for the same reason: the Federal Reserve might soon be backing off of its bond-buying program, and that changes a lot of things.
Higher interest rates mean the cost of borrowing rises, and that can slow down economic activity if they rise too quickly.
Stocks depend on rising earnings, which result from a growing economy.
Another possible reason for the decline could be that the Fed has spent nearly four years telling investors and the general public that it has to do these QEs. The Fed has said that without QEs, the markets and the economy wouldn’t recover.
If that is the general prevailing wisdom, then surely a withdrawal from such a policy will be bad for the economy. Right?
Don’t pay too much attention to the short-term “why’s” — they are not possible to answer, but they make for great TV for the pundits.
Volatility has been low since the Fed intervened with its monetary stimulus support. Though there have been a few spikes in the last few years, brought on by “fiscal cliff” wrangling in Congress and the ongoing euro crisis, we in the United States have had a lower-than-normal volatility since the 2008 credit crisis.
But count on this: As the Fed exits its massive bond-buying program and then later begins to increase short-term interest rates, market volatility will increase.
About Bryan D. Beatty
Bryan Beatty is a Certified Financial Planner™ professional and a partner at Egan, Berger & Weiner LLC, which is based in Northern Virginia. With more than 20 years of experience in the financial industry, he is a principal of this independent financial services firm, which is experienced in all aspects of investment and retirement planning.
An active member of the Financial Planning Association’s Career Development and College Outreach Committees, Beatty is a graduate of the University of Maryland with a BS in Finance. He was the former president of the Finance, Banking and Investment Society, and he is an avid musician who plays guitar and writes music in his spare time, and occasionally plays area venues. Originally from Baltimore, Beatty has lived in Northern Virginia since 1992.
For more information about Beatty’s services, send him an email at email@example.com.
_Securities and Investment Advisory Services offered through Voya Financial Advisors, member
SIPC. Egan, Berger & Weiner, LLC is not a subsidiary of nor controlled by Voya Financial Advisors._
September 13, 2013, 1:30-8 p.m.: Charity Golf Tournament
Don’t miss Bryan Beatty’s 2nd Annual Charity Golf Event to Raise Money for the Alzheimer’s Association.
TIME: 12:30 p.m., Check In • 1:30 p.m., Shotgun Start • 6 p.m., Awards / Dinner
PLACE: Reston Regional Golf Course, Reston, VA (soft-spike course)
FEE: $150/golfer, or $525/foursome
PAYMENT: Please pay by check made payable to “Bryan Beatty, FBO Alzheimer’s Association.” Net proceeds from fees and sponsorships (after costs) will be donated to the Alzheimer’s Association.
NOTE: “I am hosting this event because I have seen the effects of Alzheimer’s on many of the families I have worked with as a financial planner,” Beatty says. “In my experience, this is one of the toughest issues that we have to deal with, and I want to do something to make a difference.”
Consider these statistics:
- 5.4 million Americans are living with Alzheimer’s disease.
- One in eight older Americans has Alzheimer’s disease.
- Alzheimer’s disease is the sixth-leading cause of death in the United States and the only cause of death among the top 10 in the United States that cannot be prevented, cured, or even slowed.
- More than 15 million Americans provide unpaid care valued at $210 billion for persons with Alzheimer’s and other dementias.
- Payments for care are estimated to be $200 billion in the United States last year.
Of course, golf outings are also great ways to make friends and build business relationships.
Here’s to doing well by doing good—on and off the course!
October 3, 2013: Don’t Miss EBW’s 10th Annual Back-to-School Night!
Details: If you had the opportunity to attend the 9th Annual Back-to-School Night, you’ll remember that hundreds of guests had a ball celebrating Client Education Night.
In addition to a gourmet buffet, open bar, and a show featuring vintage cars from Ralf Berthiez, the evening featured educational presentations and activities that covered topics of interest to our clients.
Speakers included: John Ryan, VP and municipal specialist at BlackRock; CFA Jim Rullo of The Hartford/Wellington; and Christine Munroe Clapsis, Fidelity’s federal government relations director.
That’s not all: The Alzheimer’s Association’s Abigail Reinecker was also in attendance to accept EBW’s donation of $5,000, raised in September at the firm’s first annual golf tournament.