What Happens To Bond Prices When The Fed Hikes Rates?

The sharp move lower in the 10-year Treasury yield yesterday after the Federal Reserve’s (Fed) rate decision and policy announcement caught many off guard.

Most folks think that when the Fed hikes short-term rates, bond prices should fall (and yields rise) as inflation eats away at bond holders’ principal. While this may be the case over time, does this hold true during months immediately after a rate hike? What better time to research this than now, fresh off yesterday’s 0.25% (25 basis points) rate hike, the second hike in the past four months and the third time since 2015. To explore this, we analyze the price movement for the Bloomberg Barclays Aggregate Bond Index, the most widely used high-quality bond benchmark, two months after the 2015 and 2016 rate hikes.

We see in the chart below that the Bloomberg Barclays Aggregate Bond Index price rose 1.86% after the 2015 hike (12/16/15 to 2/16/16). The same pattern held for the December 2016 hike, as the index gained 0.9% (12/14/16 to 2/14/17). One possible explanation for the higher prices (lower yield) could be that when interest rates rise, the consumer has less money to spend, therefore dragging inflation lower. It could also mean that markets are simply pricing in slower economic growth and inflation moving forward because of higher short-term interest rates.

The 10-year Treasury yield fell 9 basis points yesterday to close at 2.51%, as markets broadly interpreted the Fed’s post-hike messaging as more dovish than expected, suggesting a more gradual pace of future rate hikes than markets had anticipated. So while the immediate reaction was for lower intermediate- and long-term yields (higher prices), it remains to be seen if the pattern of higher bond prices persists with this latest hike.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The economic forecasts set forth in the presentation may not develop as predicted.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

The Bloomberg Barclays Capital U.S. Aggregate Index is comprised of the U.S. investment-grade, fixed-rate bond market.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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