Rising rates has some questioning wisdom of holding bond investments

PITTSBURGH — After a long cycle of historic low interest rates, the pendulum is beginning to swing the other direction.

Interest rates have been on the rise since the presidential election in November, and this month the Federal Reserve announced another small hike to its key interest rate. Money managers believe this is only the beginning.

“The economy is improving and that’s great news,” said Paul Brahim, CEO of BPU Investment Management in downtown Pittsburgh. “The Federal Reserve believes it’s OK to take away some of the monetary stimulus. In people speak, it means they’re going to raise rates.”

The Federal Funds rate, the benchmark overnight lending target, now stands at 0.75 percent to 1 percent after a quarter-point increase that marked the second rate hike in three months but only the third in more than a decade. Fed offifficials indicated two more rate increases in 2017 were likely.

A rising rate environment has caused some to question the wisdom of holding bond investments.

There is an inverse relationship between bond prices and bond yields. As interest rates go up, the price of existing bonds fall.

“New bonds pay more interest, making your lower interest bonds less valuable,” Brahim said. “We should remember, however, that bonds mature. This means that while the value of a bond may be down temporarily, barring a default, the bonds will mature to face value if held to maturity.”

However, Mark Luschini, chief investment strategist at Janney Montgomery Scott in downtown Pittsburgh, points out that investors who own bond mutual funds and bond exchange traded funds are at greater risk when interest rates rise because those have no stated maturity date.

While rising interest rates could slowly chip away at bond values, losses could be more dramatic in worst case scenarios.

“Investors should be concerned about the scope and magnitude of potential losses if rates spike,” said Paul Jacobs, chief investment offifficer at Pali- sades Hudson Financial Group in Fort Lauderdale. “If markets reverse themselves and bonds rise quickly, people could be shocked at the losses.

Since the November election, the interest rate on the 10-year treasury bond has jumped from 1.88 percent to 2.5 percent.

Meanwhile, investors who paid $1,000 for a 10-year bond when rates were lower would only get about $9,780 for that bond at today’s rates.

F i n a n c i a l a d v i s e r P. J . DiNuzzo, president and chief investment offifficer at DiNuzzo Index Advisors in suburban Pittsburgh, said the bigger reaction to anticipated interest rate increases has come from short-term bonds.

“The t wo-year treasury s p i ke d u p i n r e a c t i o n t o the Fed statement indicating a potential rise in rates,” DiNuzzo said. “The 10-year bond is the national benchmark and the two-year bond reacted more than the 10-year bond.”

The interest rate investors receive on two-year bonds has increased from 1.20 percent to 1.32 percent, while the 10-year bond moved from 2.45 percent to 2.5 percent.