Is ongoing inflation a much bigger factor in bond returns?

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MIretired
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Is ongoing inflation a much bigger factor in bond returns?

Post by MIretired »

Given the low 0 to 1.3% returns of nom 0 to intermed bonds nom funds, isn't infl a much magnified(relatively from times past) a bigger factor of real bond returns?
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Beensabu
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by Beensabu »

You're a little late to the party (which is a good thing). That has been the rationale of so very, very, very many people for dumping their bonds and exceeding their risk tolerance over the course of this year. Based purely on yields and breakeven inflation rates, it does look like intermediate investment grade bonds may be providing a negative real return for a bit. But we won't know for sure until we get there whether they actually ended up doing that, because we have no idea if inflation over that term will meet expectations. And then of course secondary market pricing is more sensitive when rates are this low, especially the longer the duration, so who knows how it'll bounce around in the interim. Ultra short-term bonds and T-bills already have been providing a negative real return, of course. Cash has been worse. Anyway, just accept it for what it is.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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ApeAttack
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by ApeAttack »

MIretired wrote: Mon Sep 20, 2021 2:53 pm Given the low 0 to 1.3% returns of nom 0 to intermed bonds nom funds, isn't infl a much magnified(relatively from times past) a bigger factor of real bond returns?
Then get some delicious I-Bonds (see my signature) or TIPS.
May all your index funds gain +0.5% today.
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MIretired
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by MIretired »

What I mean by magnified relative effect of future inflation, if you didn't gather (not saying you didn't, but for anybody else), is: if 3 yr bonds pay 2% vs .2% , but inflation expectations for 3 yrs can vary ( std dev) from 1% to 3% in both/ either case.
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ApeAttack
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by ApeAttack »

MIretired wrote: Tue Sep 21, 2021 12:14 am What I mean by magnified relative effect of future inflation, if you didn't gather (not saying you didn't, but for anybody else), is: if 3 yr bonds pay 2% vs .2% , but inflation expectations for 3 yrs can vary ( std dev) from 1% to 3% in both/ either case.
I don't know what you are saying here.

Why are you using 3 year bonds as an example? Is it related to your investment horizon? Actually, what is your investment horizon?
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Beensabu
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by Beensabu »

MIretired wrote: Tue Sep 21, 2021 12:14 am What I mean by magnified relative effect of future inflation, if you didn't gather (not saying you didn't, but for anybody else), is: if 3 yr bonds pay 2% vs .2% , but inflation expectations for 3 yrs can vary ( std dev) from 1% to 3% in both/ either case.
I think I maybe understand what you are saying? That at this point, within the stated range of inflation expectations, the return of short-term bonds in real terms is set to be negative even if rates rise to a glorious 2%. Which is why high quality short-term bonds (along with cash) are for potential upcoming spending needs, not for long-term investment.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
secondopinion
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by secondopinion »

Beensabu wrote: Tue Sep 21, 2021 10:44 am
MIretired wrote: Tue Sep 21, 2021 12:14 am What I mean by magnified relative effect of future inflation, if you didn't gather (not saying you didn't, but for anybody else), is: if 3 yr bonds pay 2% vs .2% , but inflation expectations for 3 yrs can vary ( std dev) from 1% to 3% in both/ either case.
I think I maybe understand what you are saying? That at this point, within the stated range of inflation expectations, the return of short-term bonds in real terms is set to be negative even if rates rise to a glorious 2%. Which is why high quality short-term bonds (along with cash) are for potential upcoming spending needs, not for long-term investment.
Right on the money. Some risk of some kind has to be taken for returns to be anything decent. At least inflation is not out of control to make short term savings still worth something.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Thesaints
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by Thesaints »

At this point, bonds are not expected to contribute significantly to a portfolio return; they are just there as ballast.
As such, it is arguably better to focus on shorter dated issues than chasing meager yields. If you want yield, increase stock allocation.
secondopinion
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by secondopinion »

Thesaints wrote: Tue Sep 21, 2021 11:50 am At this point, bonds are not expected to contribute significantly to a portfolio return; they are just there as ballast.
As such, it is arguably better to focus on shorter dated issues than chasing meager yields. If you want yield, increase stock allocation.
Right that one should not chase yields, but we should not fight what the interest rates are either. For long-term investing, the risk taken with intermediate-term bonds has almost always been worth it over short-term bonds.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Thesaints
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by Thesaints »

secondopinion wrote: Tue Sep 21, 2021 12:10 pm
Thesaints wrote: Tue Sep 21, 2021 11:50 am At this point, bonds are not expected to contribute significantly to a portfolio return; they are just there as ballast.
As such, it is arguably better to focus on shorter dated issues than chasing meager yields. If you want yield, increase stock allocation.
Right that one should not chase yields, but we should not fight what the interest rates are either. For long-term investing, the risk taken with intermediate-term bonds has almost always been worth it over short-term bonds.
Generally speaking, yes. This time in particular, bonds may turn out to be more correlated to stocks than usual, the largest volatility contributor being interest rates for both. Therefore, longer-dated bonds may turn out to be a lousy ballast at the worst possible time.
secondopinion
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by secondopinion »

Thesaints wrote: Tue Sep 21, 2021 12:27 pm
secondopinion wrote: Tue Sep 21, 2021 12:10 pm
Thesaints wrote: Tue Sep 21, 2021 11:50 am At this point, bonds are not expected to contribute significantly to a portfolio return; they are just there as ballast.
As such, it is arguably better to focus on shorter dated issues than chasing meager yields. If you want yield, increase stock allocation.
Right that one should not chase yields, but we should not fight what the interest rates are either. For long-term investing, the risk taken with intermediate-term bonds has almost always been worth it over short-term bonds.
Generally speaking, yes. This time in particular, bonds may turn out to be more correlated to stocks than usual, the largest volatility contributor being interest rates for both. Therefore, longer-dated bonds may turn out to be a lousy ballast at the worst possible time.
Right. Long-term bonds can either be the bliss or bane to counteract stocks. At least intermediate-term bonds are good enough to avoid most of the downside that may happen (although they are far from perfect to say the least). As mentioned in a post of mine somewhere, moderate dips generally do not last that long for intermediate-term bonds.

I do not doubt that bonds could drop along side of stocks, but they might still counteract anyway. I rather take the side that either might happen and take a little bit of interest rate risk. I never hold near-idle investments such as very short-term bonds unless it is going to be spent soon.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
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MIretired
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by MIretired »

I know I didn't come up with a very defined question. Probably didn't think thru how much the Fed is in control of rates after so long. My ? Was alluding me to a possible extra value in tips. But I guess a higher infl doesn't directly reduce nav of nom bnds, just reduces their real return. Of course the market might reduce bnd navs. And it's all bnd durations in ? Of values, too.
BJJ_GUY
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by BJJ_GUY »

MIretired wrote: Tue Sep 21, 2021 1:09 pm I know I didn't come up with a very defined question. Probably didn't think thru how much the Fed is in control of rates after so long. My ? Was alluding me to a possible extra value in tips. But I guess a higher infl doesn't directly reduce nav of nom bnds, just reduces their real return. Of course the market might reduce bnd navs. And it's all bnd durations in ? Of values, too.
Your question is a valid one. The US Agg Bond Index has close to all time low yields, at the same time average maturities of the underlying have extended to record levels. The duration is higher than ever (or close), and the construct of the index itself is much different than historical periods, rendering back-testing for sensitivities etc. challenging (or dangerous if not accounting for all of the differences).

I think your concern has merit. Maybe not specifically to inflation, as that is tricky to predict all of the co-movements and timing that result from unexpected inflation. However, I do think that the characteristics detailed above make the AGG situated to be more sensitive to changes in the Fed's short-term rate, and also potentially more volatile movements on the longer segments of the curve (for various reasons, some of which are touched on in previous comments by others).
Walkure
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by Walkure »

MIretired wrote: Tue Sep 21, 2021 1:09 pm I know I didn't come up with a very defined question. Probably didn't think thru how much the Fed is in control of rates after so long. My ? Was alluding me to a possible extra value in tips. But I guess a higher infl doesn't directly reduce nav of nom bnds, just reduces their real return. Of course the market might reduce bnd navs. And it's all bnd durations in ? Of values, too.
I think this is starting to better describe what you mean. Let's say you believe in "taking your risk on the equity side" and that "bonds are for ballast." When bonds have a high nominal yield, the standard deviation of the nominal return ought to be larger than the standard deviation of the real return, because it is (a) measured in bigger absolute numbers than inflation, and (b) inflation could be randomly higher or lower than expected in a way that will, over the duration, tend to average out and therefore have a "damping" effect on the real return. Conversely, as nominal yield approaches zero, the variation in real return will have a higher standard deviation than that of the nominal return, because the variation of inflation will have an outsize influence on the end result.
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MIretired
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Re: Is ongoing inflation a much bigger factor in bond returns?

Post by MIretired »

Walkure wrote: Tue Sep 21, 2021 3:05 pm
MIretired wrote: Tue Sep 21, 2021 1:09 pm I know I didn't come up with a very defined question. Probably didn't think thru how much the Fed is in control of rates after so long. My ? Was alluding me to a possible extra value in tips. But I guess a higher infl doesn't directly reduce nav of nom bnds, just reduces their real return. Of course the market might reduce bnd navs. And it's all bnd durations in ? Of values, too.
I think this is starting to better describe what you mean. Let's say you believe in "taking your risk on the equity side" and that "bonds are for ballast." When bonds have a high nominal yield, the standard deviation of the nominal return ought to be larger than the standard deviation of the real return, because it is (a) measured in bigger absolute numbers than inflation, and (b) inflation could be randomly higher or lower than expected in a way that will, over the duration, tend to average out and therefore have a "damping" effect on the real return. Conversely, as nominal yield approaches zero, the variation in real return will have a higher standard deviation than that of the nominal return, because the variation of inflation will have an outsize influence on the end result.
That is a better explanation and an effect than I realized!
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