We discussed last week that USD and EUR are likely to strengthen on higher interest rate expectations in the U.S. and Europe.
However currencies are not the only ones affected. Bonds are sensitive to interest rate changes too, especially the longer dated ones.
In fact, bonds suffered the biggest losses in decades.
Let’s see the damages year-to-date using bond ETFs (duration close to 10y) as a proxy,
iShares 7-10 Year Treasury Bond ETF (IEF, in USD) -12.5%
iShares Germany Govt Bond UCITS ETF (SDEU, in EUR) -12.9%
iShares France Govt Bond UCITS ETF (IFRB, in EUR) -14.2%
iShares Italy Govt Bond UCITS ETF (IITB, in EUR) -14.2%
iShares Core UK Gilts UCITS ETF (IGLT, in GBP) -21.3%
Bond losses are very consequential for investors. It is often used as a key retirement asset and conservative investors may hold a bigger proportion of bonds.
Precisely here is the problem – investors who believed bonds were safer were treated with a rude shock this year as bonds have lost substantial amount of value that can be comparable to the stock market. They don’t expect such drawdowns.
If you are holding a bond to maturity, the price fluctuation is less likely to bother you. This is because you will get the principal back at maturity.
You can subsequently roll over the capital to a new bond at higher yields, enjoying more cash flow.
But if the maturity is many years away, you would still suffer relatively low yields while the interest and inflation rates go higher.
It is worse if you are holding a bond ETF. This is because you don’t get to enjoy the principal guarantee feature as there is no maturity date for redemption. The price of the bond ETF will keep fluctuating perpetually.
There should be more drawdown for US and European bonds as interest rates are rising. The positive thing is that those who are looking to buy bonds may be able to lock in attractive yields.
