After the United States Federal Reserve met in mid-March, the Board of Governors announced they were keeping the target overnight lending rate steady at 0.25 percent to 0.50 percent.
The decision to maintain current levels came only three months after the same group raised rates by a quarter percent for the first time since 2006.
While it’s impossible to speculate what the Fed will do for the remainder of 2016, we do know that the current overnight lending rate in the US is at historical lows.
Interest rates have a direct impact on the pricing of bond securities, which is an important reason why the Fed’s actions and guidance are monitored so closely.
A key concept to be aware of is the “inverse relationship” between bond prices and interest rates. To understand the rationale behind this relationship, imagine a declining interest rate environment. Under that scenario, newly-issued bonds arrive on the market paying a lower rate of interest than those released prior. In this case, the previously issued bonds become relatively more attractive, and prices go up.
The opposite is true in a rising rate environment, when newly issued bonds receive higher rates of return and previously issued bonds drop in price. As the Federal Reserve is expected to “normalize” rates in the US by increasing them gradually over the foreseeable future, it’s easy to see how this could be referred to as a “rising rate environment.”
To help provide further insight on potential opportunities afforded by adjustments in interest rate policy, we’ve hand-picked a couple episodes from the tastytrade library to explain this relationship.
The first is within the Options Jive series. On the show, hosts Tom Sosnoff and Tony Battista explain the somewhat lofty capital requirements of bond futures. That’s why they introduce bond ETFs as a possible alternative for traders seeking to deploy risk in the sector.
Taking a bird's-eye view of the topic, Tom and Tony present the spectrum of maturities available in bond futures and match them with bond ETFs of similar duration.
They also discuss the liquidity ratings of the bond ETFs as well as a chart comparing the 3-month correlation of bond ETFs compared to bond futures, equities, and gold.
The data reveals a high price correlation between bond ETFs and bond futures, a varying correlation (fluctuating between negative and positive) between bond ETFs and equities, and a moderately positive correlation between bond ETFs and gold.
And of course there’s Market Measures. The segment is designed to provide a more comprehensive perspective on bond ETFs by detailing how they are constructed and maintained.
If you have any questions related to the aforementioned topics we hope you will reach out at email@example.com.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.