| Waiting for Rates to Rise |
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| Written by Jared Kizer |
| Wednesday, 30 March 2011 00:00 |
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Page 1 of 2 Overview: Waiting for rates to rise is a risky strategy for at least two reasons: Interest rates are difficult to predict, and unbeknownst to most investors, current fixed income market prices already account for significant increases in interest rates.
Since interest rates started dropping in late 2007, one question investors have repeatedly asked is why does it makes sense to own intermediate-term bonds if rates are likely to rise? Let’s look at two key aspects of this question. First, other than very short-term interest rates that are heavily influenced by the Federal Reserve, changes in interest rates are difficult to predict. Second, to determine whether a short-term fixed income approach will be superior to an intermediate-term fixed income approach, you need to know rates will rise and that they will rise by more than what the market already projects. This second point is one of the most fundamentally misunderstood concepts when it comes to fixed income investing.
Predicting Interest Rate Movements
Few subjects in investing have been studied more than whether changes in interest rates are predictable. Obviously, the ability to correctly predict such changes would be enormously valuable, but research continually shows that doing so is virtually impossible.
For example, a cursory statistical analysis of changes in five-year Treasury yields over the 60-month period ending in February 2011 shows that changes in interest rates from one month to the next are practically uncorrelated.1 This brings us to the first risk associated with waiting for rates to rise: It is very difficult to know when rates will rise. In Japan, for example, interest rates have been well below their long-term average for well over a decade.2
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| Last Updated on Thursday, 31 March 2011 13:20 |