It has been a heavy-hitting couple of weeks across the global economic landscape and most of the news articles are discussing interest rates. Given this, AP Wealth has put together a short explanation of how interest rates impact bond prices.
The chart below shows the inverse relationship between interest rates and bond prices:
We have found the example below to be helpful in addition to the chart above:
Today, Sarah buys a $10,000 bond from “ABC Inc.” that pays 4% for the next 10 years. The next month, interest rates go up. Now you can buy a $10,000 bond from “ABC Inc.” that pays 5% for the next 10 years. If Sarah tries to sell you her “ABC Inc.” bond for $10,000 that only pays 4%, would you pay her $10,000 for it?
The answer is no, because you can buy a $10,000 bond from “ABC Inc.” that will pay you 5%. So, how can Sarah sell her bond?
She will have to discount it or sell it for $9,000 to get you to buy it.
However, Sarah does not have to sell you her bond. She can continue to keep it and make 4%, but the value of her bond has gone down because interest rates have gone up.
Bonds are not the only assets that are sensitive to interest rates. You will see a similar inverse price relationship with real estate, utilities, telecom, and preferred stocks.
Over the last 12 months, the 10-year treasury rate has gone from 2.87 to 1.55. Interest rates are now well below historical averages, which means interest rate sensitive holdings will have a headwind moving forward when rates go up in the future. This topic is one that our AP Wealth investment committee is discussing on a regular basis.
Please do not hesitate to reach out to us if you have any questions. You may reach us at the office at (706) 364-4281.