The bond market (AGG) (BND) has had a strong performance in the last decade, resulting from low inflation and other factors. Traditionally, there is an inverse relationship between bond prices and interest rates. The low interest rate environment that followed the 2008 global financial crisis supported the bull run in the bond markets.
However, the recent economic recovery could now draw the interest rates higher, leading to falling bond prices. The ten-year US Treasury yield increased to ~2.5% in December 2016 after hovering below 2% for six months.
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Morgan Stanley Private Wealth Management financial adviser Andy Chase feels that in the current market environment, bonds are costly compared to other investment avenues. He notes that the rise in interest rate expectations and the effect on bond prices may not come as early as expected by the markets.
Chase is drawing a parallel with the economies in Japan and the Eurozone, where interest rates have been kept low for many years. The continued high demand for high-quality bonds such as US Treasuries could help maintain the low yield.
Chase believes that low yields must rise to historical averages, which could affect bond prices. The nominal yields on ten-year US Treasury bonds have risen ~1% since August 2016, and they rose ~60 basis points after the US election in November.
After the 2008 financial crisis, we saw yields of ~4%. Current rates are about half of those seen during the pre-crisis period. Chase believes that the ~2% yield on the ten-year US Treasury note is a loser and after being adjusted for inflation, there’s nothing left for investors.
The financial and real estate sectors are significantly impacted by the change in interest rates due to their business dynamics. The major banks in the financial sector include Bank of America (BAC), Credit Suisse Group (CS), Wells Fargo & Company (WFC), and Citigroup (C).
Let’s look at the impact of the movement of interest rates on real estate in our next article.