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Market Research Group

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Waylon Green
Waylon Green

Should I Buy Bonds When Interest Rates Are Rising Extra Quality


Interest rates play a critical role in fixed income returns. When rates rise, bond prices fall. Conversely, when rates fall, bond prices rise. Navigating a shifting climate requires planning. There are a variety of strategies available, which we'll explore here.




should i buy bonds when interest rates are rising



Investing involves risk, including the possible loss of principal. These ProShares ETFs entail certain risks, which include the use of derivatives (futures contracts), imperfect benchmark correlation, leverage and market price variance, all of which can increase volatility and decrease performance. Bonds will generally decrease in value as interest rates rise. High yield bonds may involve greater levels of credit, liquidity and valuation risk than higher-rated instruments. High yield bonds are more volatile than investment grade securities, and they involve a greater risk of loss (including loss of principal) from missed payments, defaults or downgrades because of their speculative nature. Narrowly focused investments typically exhibit higher volatility. Please see summary and full prospectuses for a more complete description of risks. There is no guarantee any ProShares ETF will achieve its investment objective.


HYHG and IGHG do not attempt to mitigate factors other than rising Treasury interest rates that impact the price and yield of corporate bonds, such as changes to the market's perceived underlying credit risk of the corporate entity. HYHG and IGHG seek to hedge high yield bonds and investment grade bonds, respectively, against the negative impact of rising rates by taking short positions in Treasury futures. The short positions are not intended to mitigate credit risk or other factors influencing the price of the bonds, which may have a greater impact than rising or falling interest rates. These positions lose value as Treasury prices increase. Investors may be better off in a long-only high yield or investment grade investment than investing in HYHG or IGHG when interest rates remain unchanged or fall, as hedging may limit potential gains or increase losses. No hedge is perfect. Because the duration hedge is reset on a monthly basis, interest rate risk can develop intra-month, and there is no guarantee the short positions will completely eliminate interest rate risk. Furthermore, while HYHG and IGHG seek to achieve an effective duration of zero, the hedges cannot fully account for changes in the shape of the Treasury interest rate (yield) curve. HYHG and IGHG may be more volatile than a long-only investment in high yield or investment grade bonds. Performance of HYHG and IGHG could be particularly poor if high yield or investment grade credit deteriorates at the same time that Treasury interest rates fall. High yield bonds are more volatile than investment grade securities, and they involve a greater risk of loss (including loss of principal) from missed payments, defaults or downgrades because of their speculative nature. There is no guarantee the funds will have positive returns.


Because bond prices typically fall when interest rates rise, bond markets have long been sensitive to changes in rates by central banks. But they are also influenced by other factors such as the health of the economy and that of the companies and governments that issue bonds. Since the global financial crisis, though, the interest rate and asset purchase policies of the Fed and other central banks have become by far the most important forces acting upon the world's bond markets. In 2022, the focus of their policies shifted from supporting markets to trying to fight inflation and bond markets reacted badly.


That means angst about how interest rates might affect bond prices shouldn't obscure the fact that the return of rates to historically normal levels may present a long-awaited opportunity in bonds for those who seek income and principal protection. For years, as Managing Director of Asset Allocation Research Lisa Emsbo-Mattingly puts it, "The Fed had been financially repressing savers, especially retirees." Now, higher rates mean that retirees and savers may be able to earn attractive returns without taking much risk in 2023 and beyond.


Emsbo-Mattingly expects the Fed to continue to raise the federal funds rate further until it has an impact on inflation. If inflation comes down closer to the 2.5% range where the Fed wants and expects it in 2023, real rates, which are bond yields minus the rate of inflation, could rise further into positive territory. This would help high-quality bonds to once again be meaningful contributors for many retirees who are looking to supplement Social Security, pensions, and other sources of income.


The opportunities provided by higher rates could be short-lived. Getting inflation under control is the focus of Fed policy in the months ahead, but the central bank also wants to make sure it has room to cut rates if the economy goes into recession, potentially in 2023. Rate cuts are the most powerful tools the Fed has to stimulate economic growth and the central bank wants to be able to make impactful cuts when necessary. That could mean that the opportunity to add low-risk, high-yielding bonds to your income strategy may not be there if you wait too long.


Funds and ETFs offer exposure to the ups and downs of markets where prices change on a daily basis. When interest rates rise, bond fund and ETF prices tend to fall. But when interest rates begin to fall and bond prices rise, bond fund and ETF holders have the potential to benefit.


If you're considering individual bonds, you should know that the bond market is large and diverse and getting the best prices can be tricky. Fidelity can help by offering a wide range of ways to research bonds as well as professional help to construct a portfolio that reflects your needs, your tolerance for risk, and your time horizons.


In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.


Lower yields - Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.Interest rate risk - Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.Call risk - Some Treasury securities carry call provisions that allow the bonds to be retired prior to stated maturity. This typically occurs when rates fall.Inflation risk - With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to TIPS, which are inflation protected.Credit or default risk - Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.


Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility, as well as to the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value in the case of exchange-traded notes). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile, detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.


Some stabilization in U.S. Treasury rates could be a catalyst for emerging markets (EM) inflows. We saw that occur over the last few months of 2022 during a period of light EM bond issuance, and historical data suggest an improving trend. That should bolster the supply/demand picture for EM, as we see another year of net negative supply.Our more favorable view on the sector late last year benefited from the 125 bps rally in spreads, but it leaves us less constructive today with valuations no longer cheap.Country fundamentals are broadly stable, but we anticipate significant credit differentiation as the global economy slows down in 2023. This will create opportunities for relative value and active management.Our preference for higher-quality bonds is balanced by the fact that spreads in investment-grade EM are very tight and additional borrowing is likely. The high-yield segment of EM offers much more compelling valuations but is also the most vulnerable to further economic disruption.We see 2023 as a market where the best strategy is to be defensive but agile, with enough liquidity to act on new opportunities that arise. 041b061a72


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