Scared? Try this instead.

Predictions of higher interest rates are as common as complaints about snow in Boston this winter.  When will it end? We know our record snowfall will end but forecasting the end of low interest rates is no sure thing. Just ask Bill Gross, the Bond King, who guessed so wrong that he lost both his crown and his job with Pimco. Or Japan, well into its second decade of zero rates. If rates rise, what will it mean for investors? Bloomberg has some eye-opening stats for you.

Let’s start with the bad news
On any given day you can find out exactly how much US Treasury debt is outstanding. As of this writing the number is a mere $18,125,876,697,430.99. If interest rates rise, the value of outstanding bonds instantly falls. That’s the certain math of fixed income investments. In fact, if rates rise by one percentage point, “holders stand to lose about $570 billion”  according to Bloomberg. Six years ago the same event would have caused a loss of $170 billion. Why? Two reasons: we have about twice as much debt now and the “average maturity of Treasuries is now poised to reach an all-time high this year.” Clearly, bond investors are hoping rates stay low or they will lose half a trillion dollars. For starters.

What’s the good news?
This protracted low interest era has saved us all some money, and not just in lower mortgage payments. “The shift (to longer maturities) is saving money for American taxpayers” according to Bloomberg. It’s giving the US more time to pay back investors. Average maturity is now at 68 months, just shy of the 70 month high of 2001, says Bloomberg. Even though we have more debt, it costs less. We pay less in interest now than we did in 2008. Low rates are great for issuers and transfer more risk to the buyer/investor.

What’s it mean for you?
The track record of interest rate forecasters is dismal so please be wary of predictors, seers, gurus, prognosticators and pundits on this one. See What The &%#?Forecast!!! When interest rates go up, which history suggests they will at some point, it will affect your portfolio value. But by how much? Since bond prices and yields are linked by arithmetic it is easy and precise to understand how much money you will make (or lose) with bonds with a given change in interest rates. It’s called a “sensitivity analysis” in bond market jargon and your professional should provide it to you. If not, call us and we’ll do it. Instead of being scared, don’t guess, just analyze. Bond math don’t lie.

John Osbon – josbon@osboncapital.com