Over the last thirty years, the trend of interest rates has been declining. As interest rates decline, the price of bonds that consumers can pay goes up.
The Inverse Relationship between Bonds and Interest Rates
I will give you a quick example.
If interest rates are 5% and bonds are $100, say the interest rate decreases to 4% or 3% or 2%, then the price of bonds increases. Let’s say the rate goes down to 4%. The cost would then be $105. If the rate goes to 3%, the bond could be worth $110. If it goes to 2%, it would be $115, and vice versa. So here is the problem that I see with bonds: We are at our lowest rates ever. The 10 year treasury is at 2.20 and is now down to 1.70, at the time of this writing. They have had a 30 year bull-market.
Where can interest rates go from here if they are already at 2%? I only see three options;
- Interest rates continue to go down to zero, and if that is the case we are in for a global recession and the cost of your bonds increase are not going to make you happy. This is because everything else will start to collapse. Visit the following article here.
Could U.S. 10-Year Yields Turn Negative?
It’s an inevitable question: Could U.S. 10-year yields turn negative now that German 10-year yields have fallen below zero for the first time ever? Not to mention Japanese 10-year yields have dipped to record lows of negative 0.17 percent.
According to Dennis Davitt, partner at Harvest Volatility Management and a noted options market veteran, it may well happen.
“I think you could see negative rates in the U.S. If Germany and other countries in the world go even further negative. It turns into a number line game. So where zero lies on the number line, who knows?” Davitt said Tuesday on CNBC’s “Trading Nation.”
He sees rates being driven lower by two factors in addition to overall slow global growth: Stimulative central bank policies and regulations.”
- Option number two, interest rates can go up, now as I said before that interest rates go up, bond values go down. So if you are holding that $100 bond, and interest rates go from 2% to 3% to 4%, that bond now goes from $100 to $95 to $90 that you are holding. That is not good for our retirees that are trying to live on this income or for consumers trying to buy houses or cars.
- Option number three and this is most likely what is going to happen and there are ramifications on this as well but there is no change. We kinda bounce along at the bottom for the next five or six or seven years. Where the 10 year is fluctuating between 1%and 3% so we kinda keep just going up and down and kinda hugging that 2% line. If that’s the case, that doesn’t impact us as consumers directly right now. This is what the fed says into 2017.
Fixed Annuity Vs. Bonds
To summarize I would actually opt for a fixed annuity rather than a bond. Because I know if interest rates rise, my value cannot go down (full disclosure if you buy individual bonds and hold them until they mature they will not go down either, but read this article for bond risks).
When buying a fixed annuity I know, regardless of what interests rates do, my rate is locked in for that term of the fixed annuity.