Short Duration Bonds
Annual Total Returns

Return Comparisons in Periods of Rising Interest Rates

In the last four periods of rising rates (1994, 1999, 2004, and 2005) the advantage of owning shorter maturities instead of longer maturities is noticeable in the total returns in three of those periods.

It is important to remember that total returns include both interest income and market value change. Changes in market value look much more severe than total returns. For example, in the 1993-1994 period above, the 30-year bond declined over 23% in market value.

However, every market cycle is unique. In 2004 the market reaction to Fed rate increases was a curve flattening rally which benefited longer maturities as the 30-year Treasury returned almost 9% in the face of rising short-term rates. In 2005, the yield curve continued to flatten even more, and the 30-year Treasury again returned almost 9%. At year end 2005, the yield curve from 2-year to 30-year was virtually flat, with only a 14 basis point differential between the two maturities. At the end of 2006 the curve was inverted. At year end 2009, the yield curve from 2-10 years was historically steep at over 280 basis points.

Investment and “market timing” considerations

Bond market prices and yields are determined more by investors and their perceptions rather than the Fed’s overnight rate actions. Therefore the more conservative approach would be to maintain allocations to conservative programs rather than trading or managing in reaction to the Fed’s actions.

Interest rates of different maturities do not move together. At the time of the Fed’s increase in the overnight target may be met with declines or larger or smaller increases in longer maturity issues the prices of which are determined by investors in the market rather than the Fed. It is important to remember the anticipatory nature of the markets and that investor perceptions, which reflect their anticipations, are subject to “error” and abrupt change.