LONG TERM BONDS & INTEREST RATES
Live chart of the Long Term Bond Price & how to play Rising & Falling Interest Rates
What is a Long Term bond?
A long-term bond is a debt security that has a maturity date that is typically more than 10 years into the future. Long-term bonds are issued by governments, corporations, and other entities to finance long-term projects, such as infrastructure development, research and development, or expansion.
Long-term bonds typically offer higher yields or interest rates than short-term bonds because they carry greater risk due to their longer duration. The longer the maturity of the bond, the greater the risk that its value will be affected by changes in interest rates, inflation, and other economic factors.
The 20-Year Bond Index ETF - The TLT can be bought by Investors as a
proxy for long term bonds
The TLT ETF is a proxy for long-term U.S. Treasury bonds and the live price chart can be seen above. The ETF seeks to track the performance of the ICE U.S. Treasury 20+ Year Bond Index, which is comprised of U.S. Treasury bonds with remaining maturities of more than 20 years. As a result, the TLT provides exposure to the performance of a basket of long-term U.S. Treasury bonds.
Investors who want to gain exposure to the long-term U.S. Treasury bond market but may not want to invest in individual bonds or do not have the necessary capital to invest in a diversified bond portfolio can invest in the TLT ETF instead.
The Inverse relationship between Bond Prices & Interest Rates
The relationship between bond prices and interest rates is inverse, meaning that when interest rates rise, bond prices fall, and when interest rates fall, bond prices rise. This relationship exists because bonds are fixed-income securities that pay a set coupon rate, and when interest rates rise, newly issued bonds offer higher yields, making existing bonds less attractive.
For example, let’s say an investor purchases a $1,000 bond with a 5% coupon rate and a 10-year maturity. The bond pays the investor $50 in interest each year for 10 years. If interest rates remain constant over the next 10 years, the investor will receive $50 in interest each year and receive the full $1,000 principal at maturity.
However, if interest rates rise to 6%, a newly issued bond with the same characteristics as the investor’s bond would pay $60 in interest each year. As a result, the investor’s bond becomes less attractive to investors who can purchase a new bond with a higher yield. To sell the bond, the investor must reduce its price, which reduces the yield on the bond and compensates the buyer for the lower interest rate compared to newly issued bonds.
Conversely, if interest rates fall to 4%, a newly issued bond with the same characteristics as the investor’s bond would pay only $40 in interest each year. The investor’s bond becomes more attractive to investors seeking higher yields, and the price of the bond increases, reducing the yield on the bond and compensating the buyer for the lower interest rate compared to newly issued bonds.
In summary, when interest rates rise, bond prices fall to reflect the lower relative value of the fixed coupon payments, and when interest rates fall, bond prices rise to reflect the higher relative value of the fixed coupon payments. This inverse relationship between bond prices and interest rates is important for investors to understand when making investment decisions in fixed-income securities.
What causes Long Term Bond Prices to Fall
Several factors can cause long-term bond prices to fall, including:
Rising interest rates: As interest rates rise, the yields on newly issued bonds increase, making existing bonds with lower yields less attractive. As a result, investors may sell existing bonds, causing their prices to fall.
Inflation: When inflation rises, the purchasing power of future bond payments decreases, reducing the value of existing bonds. Investors may sell bonds in response, leading to a decline in bond prices.
Changes in economic conditions: Economic conditions such as GDP growth, employment, and consumer spending can affect the demand for bonds. In a strong economy, investors may shift away from bonds and toward riskier assets like stocks, causing bond prices to fall.
Changes in credit quality: If the creditworthiness of the bond issuer deteriorates, investors may demand higher yields to compensate for the higher risk, leading to a decline in bond prices.
Liquidity concerns: If investors become concerned about the ability to buy or sell a bond at a fair price, they may sell the bond, leading to a decline in bond prices.
In general, long-term bonds are more sensitive to changes in interest rates than short-term bonds because of their longer maturity. This sensitivity, known as duration risk, can cause long-term bond prices to fall more sharply in response to rising interest rates than short-term bond prices.
What causes Long Term Bond Prices to Rise
Several factors can cause long-term bond prices to rise, including:
Falling interest rates: As interest rates fall, the yields on newly issued bonds decrease, making existing bonds with higher yields more attractive. As a result, investors may buy existing bonds, causing their prices to rise.
Low inflation: Low inflation may increase the value of future bond payments by preserving the purchasing power of those payments, making existing bonds more valuable. This can lead to an increase in bond prices.
Economic uncertainty: During periods of economic uncertainty, investors may seek the safety of bonds over riskier assets, leading to an increase in demand for bonds and an increase in bond prices.
Central bank policy: Central banks can influence interest rates and bond prices through their monetary policy. For example, when central banks engage in quantitative easing or other policies to lower interest rates, it can lead to an increase in bond prices.
Changes in credit quality: If the creditworthiness of the bond issuer improves, investors may demand lower yields to compensate for the lower risk, leading to an increase in bond prices.
It’s important to note that the factors that cause long-term bond prices to rise or fall are often interrelated. For example, central bank policy can influence interest rates and inflation, which in turn can affect the value of future bond payments and demand for bonds. As a result, understanding the complex relationships among these factors is important for investors seeking to make informed decisions about investing in long-term bonds.
Using the Macroeconomic outlook to trade the TLT
A macro investor can take advantage of trading the TLT ETF by using fundamental analysis to analyze macroeconomic factors such as inflation and interest rates, as well as economic indicators such as GDP growth, employment, and consumer spending. By analyzing these factors, a macro investor can gain insight into the likely direction of interest rates and inflation and make informed decisions about whether to buy or sell the TLT ETF.
Depending on their outlook for inflation and interest rates:
If they feel that inflation and interest rates will rise: They could take a short position in the TLT ETF. This is because rising inflation and interest rates can cause bond prices to fall, as investors demand higher yields to compensate for the increased risk of inflation. Shorting the TLT ETF would allow the investor to profit from any decline in bond prices.
If they feel that inflation will fall and interest rates will fall: They could take a long position in the TLT ETF. This is because falling inflation and interest rates can cause bond prices to rise, as investors are willing to accept lower yields to protect their capital. Taking a long position in the TLT ETF would allow the investor to profit from any increase in bond prices.
It’s important to note that trading the TLT ETF based on macroeconomic factors can be risky and requires a thorough understanding of the markets and the factors that drive bond prices.
Why the Short Term Bonds are not affected as much with Interest Rate Changes & thus the Macro Environment
Short-term bonds are fixed-income securities that have a maturity of less than five years. The SHV ETF is a proxy for short-term bonds and its live price chart is displayed below for comparison.
When the Fed raises interest rates, short-term bond prices generally decline, but to a lesser extent than long-term bonds. This is because short-term bonds typically have lower durations, meaning that they have less time until maturity, and as a result, are less sensitive to interest rate changes than longer-term bonds. As a result, short-term bond prices typically decline less than long-term bond prices when interest rates rise.