interest rates

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19 Nov 2025

What is a Bond & Why Are They Important?

By glen

Investment portfolios generally consist of stocks and bonds, but stocks seem to get all of the attention.  Stocks seem easier to understand conceptually, companies feel tangible because we might know a company name or use a company’s products, and brokers have always made it easy to “invest” in hot stocks.

Bonds are generally considered a safe haven, functioning as ballast while earning modest, and predictable, long term returns.  Let’s take a deep dive into bonds: the types, how they behave, why they are important, and ways they can sometimes become risky.

The Humble Bond

A bond is simply a loan that pays interest and matures at a future date, typically issued in $1,000 increments that can be bought and sold on a public market like stocks.

Much like car loans and home mortgages, the better the credit of whoever is issuing the bonds, the lower the interest rate, and higher the certainty that the bond holder will be paid as expected.

Also, much like car loans and home mortgages, the longer you’re borrowing, the higher the rate.  Typically, a bond maturing in thirty years pays more than one maturing in five years.

Types of Bonds

United States Treasury & Agency Bonds

The United States government is one of the largest issuers of bonds in the world, and bonds sold by the US government are considered some of the safest available.  The assumption is that the US government will never fail to make a payment on a bond.  This is why investors flock to these bonds when panic strikes: they are a safe haven.  Because the credit of the US government is generally considered perfect by global investors, these bonds typically have some of the lowest interest rates in the market.  The lower return is the cost of safety.

The next largest bond market is very similar to US government bonds and is largely made up of home mortgages.  When you take out a mortgage, the bank often sells that mortgage to a company like Fannie Mae.  Fannie Mae bundles mortgages into bonds that are then sold on the public market.  These are also considered very secure because the issuer covers mortgage defaults, and issuers like Fannie Mae are US government entities, which means there is another credit backstop in place.

Corporate Bonds

The next largest bond market comes from corporations, and this is where credit begins to play a role.  The easiest way to think about corporate bonds is that companies with great credit pay the lowest rates while companies with less than great credit pay the highest rates.  The bonds of companies with great credit ratings are often referred to as investment grade bonds, and the bonds of companies with lesser credit ratings are often called high yield bonds because the interest rates are higher and high yield has a better ring to it than “junk bonds”, but high yield and junk bond generally mean the same thing.

Municipal Bonds

The last major grouping of bonds are municipal (“muni”) bonds.  These are bonds issued by states, counties, cities, towns, and other municipalities.  The interest paid on most muni bonds is tax free, but it’s not “too good to be true.”  This special status was created so states, cities, and towns would not have to compete with the US government bond market and risk being “crowded out.”

The downside: because these bonds are tax free, they have significantly lower yields.  These bonds are only appropriate for people in the highest tax brackets because at those tax rates these bonds become more attractive than corporate bonds and government bonds.  There is a calculation called “taxable equivalent yield” that your financial advisor or CPA can use to determine if these bonds are appropriate for you.  This calculation tells you the yield a taxable bond must offer to equal the tax-free return of a muni bond for your specific tax bracket.  If you’re in a mid to lower tax bracket, muni bonds may not be your best option.

Credit is also an issue here as well because cities, counties, and other municipalities have defaulted, causing a mess for investors.

If Bonds are Safer then Stocks, then How Risky Can It Get?

Bonds have a nemesis called inflation.  In order to offer any actual return a bond must consistently pay more than the prevailing rate of inflation.  If inflation creeps up during the life of the bond, the real return comes down.  If inflation were to drop, you might get a small lift.

This inflation threat is one of the reasons even the most conservative investors should hold some stocks.  Over the long term stocks are the best hedge against inflation because corporations always increase prices as inflation rises, which helps ensure that earning beat inflation.

But the market is prone to fits.  When stocks quickly lose 10% or 20% of their value this long term inflation argument falls flat as investors cling to bonds for protection, but it’s worth noting that stocks typically recover and begin gaining again within twelve months of these big drops.  It’s always about the right balance of investing long term while knowing things can go sideways fast in the short term.

The other major risk with bonds is default.  If an issuer goes bankrupt, bondholders might be out of luck, but this can be a long downward spiral as the credit rating and price of bonds drop over time.  In the event of a bankruptcy bondholders are typically paid first as a company is liquidated while common stockholders are usually dead last.

When Yields Go Down, Prices Go Up

The price of bonds and the rate or yield are inversely related.  If interest rates go up, the prices of bonds drop, if interest rates go down, the prices of bonds rise.

A simple way to think about this see-saw is to imagine a bond priced at $1,000 and paying 3% interest annually.  If interest rates on similar bonds rise to 3 ½% our bond must yield 3 1/2%, since the interest rate it pays is fixed, the only way for this bond to yield more is for the price to drop, meaning buyers become willing to buy the bond at $965 or a discount.  If held to maturity, the holder will receive $1,000 from the issuer and the lower price it was purchased at provides that extra ½% of return.

If similar bonds begin yielding 2 ½%, our bond is now worth $1,044.  The higher price compensates the seller of the bond for the decline in yield.

When the Federal Reserve changes the Fed Funds rate or the overnight lending rate between banks, all interest rates shift up or down slightly to compensate for that change in the fundamental cost of money. Different types of bonds and different lengths of bond terms impact how sensitive they are to these changes in the overnight rate.

When the Fed cuts interest rates our bond portfolios will rise in dollar value as the yield & interest received drops.  When the Fed raises rates our bond portfolios decline in value as our yield & interest received increases.  It is a double edged sword.

Major changes to inflation will have a similar effect: if inflation unexpectedly increases, bond yields must rise to compensate investors, and bond prices will drop.  Also, the longer the term of the bond the more sensitive the price is to changes in interest rates.  There is a lot more uncertainty about all of the things that can happen over thirty years than over five years.

Just as a side note, you can think about these examples when it comes to home mortgages.  Ultimately the rate you pay on a home mortgage is determined by the prevailing yield on the mortgage bonds we discussed earlier because ultimately that mortgage is going to end up in one of those bonds.  This is why mortgage rates may not perfectly mirror changes made by the Fed: what they are really mirroring is where the bond market prices the mortgage bonds that are the end product.

Wrapping It Up

The easiest, lowest cost, and most effective way for most investors to buy bonds is via a low cost exchange traded fund (ETF) or no-load, low-fee mutual fund.  There are a lot of great options available that allow you to determine exactly the type of bonds you want to own.  The institutions that manage these funds buy in massive quantities, which helps them achieve the best price possible in a given market, they also manage the holdings.  If a company’s credit slips from investment grade to “junk bond” status, the issuer will sell that bond and replace it with a bond that meets the fund’s stated objectives.

This is also something an investment advisor can manage for you, and we are here to help!

I hope this blog has been helpful and has offered you a fresh perspective on the humble bond.

 

 

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities. 

29 Aug 2024

Interest Rates Are Coming Down: The Good & The Bad (not too ugly)

By glen

Interest rates have been elevated for over two years now.  This is the result of the Federal Reserve fighting the post pandemic inflationary fire.  Higher rates are the primary way to lower inflation, and this is a time tested remedy, rewarding savers, while punishing borrowers and some investors.

Let’s look at where we are now, where we’re headed, and the anticipated impact of the coming changes.

Where We Are

Higher rates have rewarded cash savers for the first time in a generation. With money market rates exceeding 5%, it’s been a nice return for zero risk.  CD yields have been juicy too.  It’s a boon for those who can’t stomach investment risk, and very nice for those of us who hold some cash in a diversified portfolio.  For others it has been a painful struggle.

Bonds are important to all but the most aggressive investors and bond prices tanked as rates were pushed up.  A bond’s price moves inversely to yield (interest rate).  Yields going up means prices going down, and that’s painful when bonds are supposed to offer safety.

Home prices spiked as the pandemic peaked, and the value of everything went up all at once due to the flood of cash that led to the inflation spike.  This was followed by a painful increase in mortgage rates.  These are the highest mortgage rates in a generation, keeping many people out of the home market.  People with super low mortgages had no incentive to move, and trade up or downsize, which translated to a lack of sellers and homes families and aspiring families could afford.

Lending markets of all types have struggled making it harder for the economy to grow, while higher rates have tamed an economy that was on fire with inflation.  The list goes on regarding the pain of higher rates.  Auto loans have been a burden for many families, and small businesses have struggled with financing because they tend to borrow for shorter terms at rates that are higher even when rates are “normal”.

Where We’re Going

Inflation by all measures is trending back toward pre-pandemic norms, which is around 2.5%.  The job market is finally showing some signs of slowing.  This combination frees the Fed to begin cutting rates, and they’ve made it pretty clear this will begin at their September 18th meeting.

The market anticipates three to four rate cuts, totaling 0.75% to 1%, by the end of 2024, with a potential 2% drop over the next year. However, economic conditions can change rapidly.

The prices of longer term bonds have already begun to rise in anticipation, with people who sell bonds for a living waxing philosophically about the once in a generation opportunity in bonds.  In my humble view, this is just getting back the once in a generation loss we experienced as rates spiked.  Either way, bond prices rebounding is great news, getting us back to a new normal.

Mortgage rates will drop significantly as well.  They are already down more than 1% from highs in many markets.  That trend will continue, and hopefully, the residential real estate market will rapidly thaw as we head into spring.

Car loans will drop, allowing families to make better transportation decisions, and keeping auto workers employed and spending those paychecks further bolstering the economy.

Risk averse savers will have to say goodbye to juicy money market and CD rates.

Wrapping It Up

In many ways, this marks the end of pandemic era financial turbulence.  The ride down in rates will be refreshing for all but the ultra-conservative saver.

The trick for the Federal Reserve will be getting rates down fast enough to prevent a recession, which markets call a soft landing.  While bond prices may move quickly in economics there is a strong belief that it takes six months or more for any rate change to fully play out in the economy.  A September rate cut of ¼% will not be felt in American homes and businesses until March.  If a recession should happen next year, the consensus is that it will be short and shallow, with the headlines being worse than the reality for most.

If you have been enjoying the high money market and CD rates, we’re here to help you build a portfolio that meets a conservative risk tolerance for the long run.

 

 

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities. 

02 Jun 2022

The Hangover: Too Much Money

By glen

The Big Cash Party

As the worst of pandemic fears fade into memory it’s easy to forget the panic of 2020.

A “shutdown” had never been attempted, and amid the fear, uncertainty, and market panic, the Federal Reserve did the only thing it could do to help: print money.

It printed $4 trillion.  While this didn’t involve literally running the printing press, it created that much cash out of thin air.  What they really did was buy bonds on a massive scale.  When the Fed buys a bond from a bank it gives the bank cash for the bond, and that cash is freshly minted on the spot.

The flood of cash was helpful during the worse of the pandemic, it kept the markets lubricated and functioning relatively normally.  The fresh, new cash was the spiked punch in the punchbowl.  Cash in hand, investors bought everything they could.

Bond prices ran up, pushing interest rates down.  Stocks moved to record highs on valuations that made little sense.  We saw crypto currencies move into the spotlight and surge.  We saw home prices take off on cheap mortgages.  We saw new inventions like NFTs spike.  Why were people paying steep prices for things like the exclusive right to an NBA slam dunk video?  The list keeps going.

People were flush with cash, stuck at home, and drinking the Fed’s spiked punch.  To prevent a panic the Fed kept the punch flowing for too long, which they’ve now admitted.

The punch bowl was allowed to run dry in March when the Fed stopped buying bonds, and began increasing interest rates.  The hangover begins.

The Hangover

When lots of new cash is printed, under normal circumstances, the result is a spike in inflation.  Because of the complexities of the pandemic world it took a long time for the inflationary fire to get started.

The Fed was caught off guard, and did the only other thing the Fed can do, destroy money.  It began raising interest rates, told the markets it will keep raising interest rates, and announced a plan to start destroying some of the newly printed cash.

The bottom line: with cash leaving the economy en masse, the tide is going out.  This hangover has two painful symptoms: the inflationary fire caused by the high proof punch, and the Fed’s action of taking away the punchbowl by pulling out that cheap, new money, which puts downward pressure on almost all financial assets and growth.

The economy survived the pandemic, but now we’re in a painful place.  We see costs rising in real time, and our investment portfolios have taken a bruising.

Let’s look at stocks and bonds.

Bonds

Inflation is kryptonite to bonds.  As prices rise the purchasing power of bonds is eroded.  Prices and yields have a seesaw relationship.  When yields go up, prices go down.  Since bonds are expected to compensate for inflation, as inflation has increased, bond yields have increased to keep up, pushing prices down.

This is being exacerbated by a Fed that: stopped buying bonds (printing cash), began increasing the Fed Funds rate, which pushes all rates up, and burning money by letting bonds it owns mature without reinvesting the cash.

We haven’t seen this since the 1980’s, but it’s the same playbook.  The only way to put out an inflationary fire is to make money more expensive.  In the world of bonds what’s happened so far this year is as rare as it is painful.

The good news, the worst may be over for bonds.  The bond market is looking over the horizon, and sees a slowdown coming.  The bond market sees a Fed that could be forced to begin cutting rates in less than a year to combat a recession it helped create.  You read that right.

Stocks

If the bond market was the somewhat reserved partier through all of this, the stock market was like the cast of Animal House.  Stocks spent most of last year exceeding any reasonable valuations, and chanting drinking songs as if the speed of the pandemic recovery would be the speed of growth forever.  It was bizarre.

In January an inebriated stock market looked around and saw the bond crowd piling into Ubers, and realized the party was over.

Stock prices now only look fair in terms of bloated estimates that still haven’t come down.  The hangover could worsen here as prices begin to reflect an economy that is slowing down.

Despite the pain, with a long term perspective, stocks have a better shot at fighting inflation.  As inflation rises, companies charge more for goods and services, which allows earnings to keep up with inflation.  While earnings may drop with an economic slowdown, price increases offset the bite of inflation in the long run.

Wrapping It Up

The hangover has been painful, and the pain is likely to continue, possibly to the point of a recession within the next twelve months.

The Fed did what it had to during the depths of the pandemic to keep the economy from unraveling.  Printing, or destroying money, is always a blunt force that lacks precision.  The system doesn’t turn on a dime, and The Fed waited too long to take the foot off the gas.

Bonds may have turned the corner in that they are now rising as stocks drop, which is the typical relationship as investors seek the shelter of bonds amid uncertainty.  Inflation is close to a peak, and should begin a long road back to “normal.”  Stocks are getting close to reasonable values, but remain rocky.

The good news: we still have a functioning economy, something that shouldn’t be taken for granted.  The bad news: it’s been a wicked hangover that’s probably far from over.

Hopefully, this is the beginning of the final chapter of the pandemic’s impact on the economy.  It was quite a “party.”

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities.