Interest Rate price - yield question

[Trader J]

Hi,

My name is John (Trader J). I am an Investor and Commodities Trader and do not have any formal back ground in Economics. Is there perhaps someone with more knowledge that can explain the following to me:
attached is a T-Notes 10 year chart with continuous back adjusted Monthly data since 1985.
My question is about the relationship between the interest rates and yield curve. When seeing this chart, how do I interpret this relationship?
The way I understood it is that there is an inverse relationship between the two: if the bond price goes up, interest rate goes down. But in this case, as the chart shows, it only has gone up?
In other words, if one knows that there is a higher probability that price will go up and therefore interest rates over time will go down, why get a fixed rate mortgage?

Your help in understanding this is appreciated.

Trader J

 

[Rhody Trader]

First, a little correction. "Yield curve" is a term used to describe the comparisson of yields among the different maturities. As such it is not the term you should be using here.

That aside, your understanding is correct that higher note/bond prices mean lower yields. It's basic math. If your periodic interest payment is $100, then your yield will be higher if the prices is $800 (100/800=12.5% yield) than it's $1000 (100/1000 = 10% yield).

As for Note prices always going up and thus yields down, While that certainly has been the overall trend as depicted by the chart A) you can see periods where that has reversed or at worst gone nowhere for long periods, and B) You're chart doesn't include the period from the 1950s to the early 1980s, which would show a quite different story.

 

[Martinghoul]

First problem is that you're looking at a time series of futures prices. It's somewhat more complicated to extract a consistent yield out of futures prices.

Secondly, I have a bit of a problem reading your price chart. Does it truly suggest that the t-note futures in 1986-87 were trading with a 20 handle?

Thirdly, your instincts are sorta correct. In a very grand scheme of things, the US bond mkt has been experiencing a secular bull phase for the last 20 years, ever since the hyperinflation of the 70s and the Volcker response. 10yr yields have gone from arnd 12% in the 80s to 3% - 4% now. If you actually want to look at a times series of 10yr bond yields, I'd recommend the official Fed H.15 data that you can find here: http://www.federalreserve.gov/Releases/H15/data.htm

Finally, as to your question about where rates go over time, it's not quite as clear as that. If you look at the data I pointed you to and go back a little further, you'll find that 10yr yields have gone from arnd 4% in the early 60s to 14% in the early 80s and are now back at arnd 4%. So it's not like they can only go down. Which period are we likely to experience next, the 70s/80s or the 90s/00s? That's the bazillion $ question...

 

[MrGecko]

As MG points out, looks like your "adjusted" futures prices are out of whack, first guess would be they have been discounted incorrectly, something along the lines of all prices being for Jun '10 delivery rather than the nearest Qtrly contract.

Also, try the tickers $TNX (10), $TYX (30) and $FVX (5) by the CBOE for "on the run" note yields. Google/Yahoo should have 'em.

 

[Trader J]

Thank you for your interesting contributions. I looked at the data as suggested - see thumbnails -both charts are from Yahoo. It looks like it confirms what I have been thinking and doing - Interest rates were in a down trend for many years. It made a huge difference in my Real Estate investments.

But now the question arises: how does one protect oneself against the upcoming inflation and (possible) rising interest rates?

 

[Martinghoul]

And that is the bazillion $$$ question...

 

[Rhody Trader]

But now the question arises: how does one protect oneself against the upcoming inflation and (possible) rising interest rates?

Borrow now to lock in the low rates and to be able to pay that loan back with cheaper money in the future. :clap:

 

[Trader J]

Does anybody have ideas about Swaps? or Options? Or hedging? in this regard?

 

[gooseman]

plenty of accounts positioned for downside move in longer end of curve in options and swaps....

 

[Martinghoul]

Does anybody have ideas about Swaps? or Options? Or hedging? in this regard?

What sorts of ideas are you looking for? There's all sorts of things you can do, but it all very much depends on your particular view.

 

[Trader J]

We invest in three different currencies. It all started with a relative small amount which has grown over a period of 10 years. Suddenly, because of the size in USD or Euro's or South African Rand, currency fluctuations have become important enough to pay attention to.
Protecting capital in terms of changes of currency exchange rate but also protecting against interest rate hikes is important. Any ideas in this regard would be appreciated.

 

[Rhody Trader]

Depending on the structure of your cashflows, it sounds like either a swap or forwards arrangement would probably be what you're after.

 

[Martinghoul]

What do you mean "protect capital against rate hikes"? If your capital is in cash/short-term deposits, there's no reason to expect rate hikes to cause you any grief. Generally, my personal principle for these things is dead simple. If you're an average person with assets that are sensitive to interest rates (such as conventional bonds), the only reasonable and cost-effective thing you can do is offset your exposure with some liabilities, such as a fixed-rate mortgage. If you're an institution, there's a whole variety of products of varying complexity that give you the ability to hedge your exposure, but then it's a matter of scale and cost.