Interest Rates Creep Higher and Higher

Only 3 months ago we had the 10 year treasury touching in the high 1.40%’s.

Today we see the 10 year treasury trading at 1.93%–a full 4/10th’s of 1 percent higher.

In general, we have not seen substantial damage to preferred stock and baby bond pricing. Sure we see some of the high quality very low coupon issues having trouble with ‘traction’ in moving higher, but the evidence shows that interest rates are having very little affect on pricing–so far.

Only today mSquare wrote on the new “Flipping and Dividend Capture” page that he/she bought the new AT&T 5% perpetual preferred for $24.9x on the OTC Grey market and just sold it on the NYSE for $25.6x. This shows that there has been hunger yet for ‘yield’ –even low yield.

Today Newman mentioned that he/she was getting a bit concerned with the 10 year treasury moving higher.

As income investors we all need to be concerned with higher rates, BUT one can not ‘run for the hills’ because there is no one that can predict what rates will do tomorrow and we all need some sort of income stream–it has almost always been true that money buried in the back yard earns little interest.

As the old commercial on the television used to say “speed kills” (of course talking about driving), but we know that interest rate movements can be fairly well tolerated if the movement is slow–2,3 or 4 basis points up one day and down 1 or 2 basis points the next. The move from 1.4x% to 1.93% took 90 days or so–and this move has been well tolerated.

At this point in time if we see a 1/8% spike higher 2 days in a row–that would be a bigger concern. The low coupon issues will act very badly if we get these kind of moves. Additionally the low coupon issues will act poorly even if we get slow moving higher rates–month after month after month.

Lastly we can never predict some major moves. A few years ago the markets threw a ‘taper tantrum’ simply because the FED suggested a reduction in quantatative easing. The 10 year treasury rose near 1/2% in 2 weeks–simply based on a ‘suggestion’ of a tapering that never happened.

So in summary I would encourage investors to do what makes them feel comfortable. If rates do pop and you lay awake nights – make some sales–store some dry powder–or if you fear the future–next week or next month–sell a little and hold the cash until you mentally feel better. I have made a few sales recently and am in no hurry to reinvest–more because I am hoping for some better pricing ahead. In my 15 years of purely preferred stock and baby bond investing every big sell off has resulted in the opportunity to buy good issues at low prices–so keep a little dry powder.

10 thoughts on “Interest Rates Creep Higher and Higher”

  1. The trend of negative yields is fading some. Swedens Central Bank Riksbank just moved from negative .25% to 0%. It was the first bank 10 years ago to go negative and set the global record at minus 1.25%. Now it has clawed its way back to zero despite their projected inflation rate of 1.7% and GDP at 1.1%.

  2. In December 2018, the 10-year treasury was at 2.85%. It fell to 1.45%. That drop was almost 50%. Yes, the 10-year rate was cut in half in 8 or 9 months. That cut lead to the number of low rate preferred issues we saw in the second half of last year. Take CFG as an example. In January, their preferred was issued at 6.35%. 10 months later, CFG’s preferred rate had dropped by 37% to 5.0%.

    Rather than give my analysis of why this happened, let’s just deal with the numbers. The numbers are what the numbers are.

    We cut short term rates by 0.75% not by 1.45%. Of course, cuts in short term rates do not have to have an exact parallel to long terms rates. However, the drop in 10-year Treasury yields looks to have been excessive. They did already cause damage to every one of us. We lost higher coupons on new issues. They also provided benefits, we got inflated prices on high coupon issues like CFG’s 6.35% trading the day before ex-div at $28.35. Way too high in my view. So we got some losses in low coupons and got some gains in high coupon rates. A smart person may book their capital gains to take advantage of the excessive gains. I am holding just like I held on buying the low coupon rate issues.

    So I 100% agree with Tim. Ideal would be to stabilize here at 1.8% – 1.9%. I truly hope he is correct. But I don’t think we are going to see that, so I expect a 2% – 2.25% range.

    What to I expect to happen as a result? We will lose some of the premium for the higher coupon issues but we will gain some higher coupon for the new issues. The problem will be, we will lose the gains on the existing higher coupons must sooner than we see the gains on the newer issues. No business is going to be in a rush to give higher coupons and increase their costs. Of course, they all quickly jumped on the lower rate bandwagon. It’s the way the game is played.

    1. BTW, I encourage all the readers of this site to go to the Canadian Discussion room. Follow the posts of Bob-in-DE, Girdbird, and some of the new members of the board like Tex. Why? Most issues in Canada seem to be fixed-rate reset issues. The existing issues don’t do well in a falling rate environment while the US market existing issues do better. However, as rates go up, this market does better. Not only in coupons but also in their pricing. A lot of these issues can be purchased via OTC market without a global trading account.

      Canada seems to offer a good hedge and looks to move in opposite directions to our markets. I own approximately 10% of the holdings in Canada fixed rate resets. If 5-year rates, continue to climb, this market may hold an opportunity for some. It is at least worth thinking about.

      I love this site.

  3. Ultimately, the past 10 plus years have shown like Tim opined, sudden spikes, and of course fear have been the culprits. As every time an advancement anywhere near towards historical normal yields has been swatted down hard.
    That being said, the all important (but never mentioned or largely understood by many income investors) credit spreads are at historically tight levels. And high yield continues its march towards historical lows. The point being here is credit spreads alone without any govt yield movement can cause price drops.
    Although I own a core, much of my money is in resets, adjustables, and a more shorter term defined limit, the minimize any of that risk if it ever comes to pass.

  4. As you mention above Tim, I am indeed a happy camper in flipping my T-A baby bond bought in OTC on 12/6 below par, today for a nice 100% annualized gain but I do have regrets not having bought a bigger quantity!

    What I bought 3-4 months ago when ^TNX was yielding lower in the 1.4s-1.5s, I already sold for nice gains. My rule of thumb is to exit when appreciation approaches the annual coupon. Lately, with the rates changing quickly, this hit-n-run technique has been yielding me good profits and I think at a lesser interest rate risk. eg. MBINO, JPM/PRJ & BAC/PRN.

    Now of course the next problem is to find the next preferred to buy with the cash generated – it is currently in my money-market account earning 1.5% waiting for the next preferred IPO

    1. mSquare–haha–we always wish that we had a 1000 shares instead of 500 when it works out—but we wish we had 200 when it doesn’t. Everyone needs to find there comfort level.

  5. That’s great advice Tim. I am in the camp lower for longer on rates, but the copper/gold ratio has been climbing lately and that has dragged rates higher. If 10y. Gets above 2.10 I think we will have problems.

  6. Saw an interview on CNBC this morning, bearded fellow, did not catch the name. He felt the 10yr would move around a bit but end next year at 1.85%. Said there are few drivers for inflation due to demographics, among other reasons. Predictions are just that but I hope he is right.

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