Tag: High Yield Bonds Page 1 of 5

US Dollar Impact on Bonds and Interest Rates

Well known technical analyst and commentator, John Murphy, CMT, authored the groundbreaking book, “Intermarket Technical Analysis”, published in 1991. He covered his research of how stocks, bonds, commodities, and currencies influence each other with varying degrees and various lead and lag times.  Armed with a ruler, a plain white sheet of paper, and a pencil, I was able to make a cross comparison grid that displayed all the asset classes he noted in the book.  Each cross comparison highlighted the direct or indirect influence, the lead, lag or coincident impact, and the typical time in months of that impact.  The US Dollar stood out on the grid because his work found that it had a leading tendency across most of the asset classes with a couple being coincidental while not being a laggard to any.  A couple of years later, in 1994, I met John at a conference.  Like a star struck teenager getting a Taylor Swift autograph, I excitedly had him sign my copy of his book.  I also showed him the grid.  He smiled and said, “perhaps I ought to add something like that to my next revision”.  That made my day.  He also said something extremely important.  He said that he was noticing the intermarket relationships were evolving…

The US Dollar is like the wind blowing through the investment world. It can act as a headwind or a tailwind to most all asset classes.

Sometimes the influence is only slight and other times the gusts can be highly influential and blow an asset sharply off course.  Over the last 25 years, the world has changed significantly.  Technical or chart-based investors focus less on the why and more on the bottom line.  That said the dollar’s role has evolved as relatively new players have entered the scene.  Historically small economies, such as China, have recently taken on greater roles in trade.  Global oil trade in US Dollars has undergone correlation changes as the US has become less dependent on foreign oil.

With what has been covered so far, there are many paths we can walk down in how the US Dollar influences other assets or is impacted by other assets. To rein it in, let’s start with bonds and interest rates.

Created with TradeStation. © TradeStation Technologies, Inc.  All rights reserved.

In our example (chart above), we will use the iShares 20+ Year Treasury Bond ETF (TLT) to represent longer-term bond prices. Keep in mind as bond prices rise, interest rates fall.  As mentioned earlier, the US Dollar is like a wind that generally blows against the direction of bond prices and in the same direction of yields.  At the risk of oversimplifying, rising rates attract dollar denominated investment.  A reason why that risks oversimplification is because investors often take action in anticipation of future events.  Therefore, the US Dollar can lead if domestic economic activity is improving, attracting investors from around the globe to need US dollars for US investments.  As economic activity improves, interest rates rise which can increase demand for dollars.  However, sometimes interest rates are held artificially low as economic activity shows signs of improvement.  I have heard it said that the US Dollar is the stock certificate of the United States.  If people are bullish on America, then they need US Dollars to put their investment plan in action.  So there really is not a consistent starting point but we can recognize the inverse nature of the US Dollar to bond prices.  Don’t be too eager to assign a cause and effect because sometimes demand for the dollar leads and sometimes it is demand for bonds.  Be satisfied in simply knowing a relationship exists.  Arrows on the chart illustrate the concept of inverse directional bias.  The general trend of the TLT has been up during the first three quarters of 2017, while the general trend of the dollar is down.  Trend direction appears to have changed in early September.

So why go through all the trouble? Investors implementing charting techniques may find it easier to analyze the dollar and then draw conclusions about bonds and interest rates.  Traditional chart methods such as breakout/breakdown implications and trend line breaks are much more misleading on charts of the TLT versus the lower volatility trending nature of the US Dollar.  No method is perfect but it only takes a quick look to conclude the price action in the TLT is more volatile than the US Dollar.

It can be very frustrating to learn a new concept and have it appear to not work. Setting expectations is important and in this case, the inverse direction bias of the dollar to bonds should not be assumed as being in rigid lock-step.  In the lower pane of the chart, two measures of correlation are displayed.  If the dollar (UUP) moves in the opposite direction as the bond (TLT), then a blue dot is plotted at -1.0.  Those are the days in which the theme of this blog is easy to embrace.  If the dollar (UUP) moves in the same direction as the bond (TLT), then the blue line is plotted at +1.0.  During 2017, there are many days in which the bond and the dollar moved in the same direction.  For example, those are the days in which a viewer may be tempted to abandon these concepts – abandoning what ultimately could be a useful concept.  A red line can be seen in the lower pane that represents a 21-day average of the 1-day correlation.  Other than in mid-February and mid-July, the rolling 21-day average of correlation fits the norm of being inversely correlated.

If we are comfortable with the idea of inverse correlation but with the understanding it is not precise, then we can take the next step. Instead of focusing on implementation of trend analysis and other charting techniques applied to bonds or interest rates,

applying methods to the less volatile US Dollar could prove useful.

Conclusions derived from chart analysis of the dollar can then be transferred over to bonds (inverse conclusions) or the interest rates (same conclusions).  Actual chart-based methods are vast and beyond the scope of this blog.  The bottom line concept is if bullish conclusions are derived after assessing the dollar then a bullish outlook on interest rates (bearish on bond prices) can be concluded.

Chart-based assessment of the US Dollar should not be the only method but can be a useful tool to investors seeking to diversify analysis techniques within bond and interest rate assessment. Lower relative volatility of the US Dollar may lead investors to insights more difficult to conclude if focusing methods on underlying assets with higher volatility such as long-term interest rates.

Duration vs. Maturity and Why the Difference Matters

Understanding the complexities of the bond market is important when evaluating the types of products and exposure a portfolio has within the asset classes of fixed income. The terms “duration” and “maturity” differ in the world of finance from their common everyday use. In finance, both duration and maturity refer to different characteristics a bond may have. Clarification of the definitions should help those wishing to dive a little deeper into what may be subtle yet important difference among bonds whether looking at fixed income mutual funds, ETFs, or individual bond issues.


How long something lasts is commonly associated with the word “duration”. An example of this would be a movie with perhaps a duration of two hours or a roller coaster with a duration of one and a half minutes.

When assessing a bond or a bond portfolio, how long the bonds last, if not sold early, is closer to the definition of “maturity”.

A 30-year Treasury Bond, as the name implies, matures or pays back its face value 30 years from its initial date. Investors are not obligated to hold the bond for the entire period as they have the option of being sold within the secondary market.  Therefore, ten years after its initial offering, a 30-year Treasury Bond will have a maturity of twenty years but is still called a “30-year” Treasury Bond.

Individual investors or portfolio managers can buy or sell bond holdings to adjust the average maturity of the portfolio. Why would they want to do that?  Generally speaking, the further out the maturity, the wider the potential price swings of the market value of the bond.  That is a very important concept to bond investors, but it is a general concept as compared to an attempt at better detailing the relationship when we cover duration.

Keep in mind bond investors recognize two types of return, the first is the interest payment income which may be paid quarterly, semi-annually or even annually.  If investing in a fixed-income mutual fund, interest payments are in the form of mutual fund dividends and may be paid monthly.  Those payment cycles will play a role when duration is covered.  The second type of return is from price changes of the bond itself (why maturity matters).  Putting the two types of returns together, an investor gets the “total return”.

Bonds are often quoted with two yields. See the diagram below to understand the relationship between the bond’s price and its interest rate (or coupon rate).

  1. A bond is quoted with its “coupon yield”. This refers to the annual interest payable as a percent of the original face or par value. An 8% bond with a par value of 1000 would receive $80 per year.
      1. Coupon/Interest Rate= 8%
      2. Original face or par value= $1,000
      3. Math= .08(1000)= $80
  2. The second is the “yield to maturity” (YTM). This quote takes into account the amount of years left until the bond matures and the impact the market and secondary trading of the original bond has had on the investors final total return.
    1. Example: 10 years later the original 8% bond with a par value of 1000 is actually trading at $950. Remembering the above diagram, this means the coupon/interest rate would be higher than the original 8%. So what would be the bond’s yield to maturity?
      1. The formula for YTM takes several things into account:
        1.      Original Coupon/Interest Payment (C)
        2.      Original Face or Par Value (F)
        3.      Price bond was purchased (P)
        4.      Years to maturity (n)
    2. If you plug in all the numbers and calculate the YTM when n=20 (10 years later…) the YTM quote is 8.46%
    3. Let’s say that 5 years later, interest rates have dropped and now the bond is purchased in the aftermarket for $1060. The Yield to Maturity is 7.38%

So what’s the bottom line when it comes to maturity?

Other than a few reasons that would cause a bond to end its existence prior to maturity, the life span of a bond tells an investor how long the bond may be exposed to risk – the primary one being the erosion of its value (purchasing power) when inflation is present (higher bond price, and a lower return than the coupon rate as in example 2 on YTM).


Plain and simple, duration is the measure of a bond’s sensitivity to changes in interest rates. Complexity increases in the details of various ways duration is calculated.  We will quickly outline the calculations but then then circle back and focus on the broader concept and why investors look at duration in conjunction with maturity.

Macaulay duration, modified duration and effective duration are three types of duration calculations. Investors will more than likely run across effective duration numbers.  It is calculated by taking into account how fast a bond’s initial purchase price will be repaid based on its cash flow – this may be a weighted average if looking at a bond portfolio such as in an ETF or mutual fund.

Despite the fancy math of the different versions, duration is more of a concept and not a tool to measure an exact expected price change of the bond when interest rates change.

So what’s the bottom line when it comes to duration? An example should drive the concept home.

An investor that purchases a bond with a face or par value of $1000 would naturally wonder how much that price could be impacted by changes in interest rates. If a bond has a duration of 6 years, then a 1% change in interest rates should cause the bond to lose approximately 6% (to about $940).  Keep in mind the image of a see-saw on a playground conveying the idea that when interest rates go up, bond prices go down and the opposite is true.

As noted earlier, duration is more of a concept that estimates the impact to the bond when interest rates change. It is an estimation of the amount of up/down swing in that see-saw image.  Ultimately, market participants determine price, but keep in mind market participants would probably be using models to calculate duration in an attempt to determine supply (selling) and demand (buying).

You may have noticed the duration example had the term listed as years. That is the norm used to note duration and also the probable reason why it is can be easily confused with maturity.  Recall that the formula(s) for duration measured how long it took for the cash flows to repay the initial investment.

Now, the bottom line of the bottom line. Two bonds may have the same maturities, but their sensitivity to interest rate changes may be different.  Investors and portfolio managers not only can diversify holdings in regards to when the holdings may expire or mature, but now can diversify holdings in regards to the possible volatility or impacts to bond price movements as interest rates change.

Take high yield bonds for example – according to the iShares website (www.ishares.com), the High Yield Bond ETF (HYG) has a Weighted Average Maturity of 4.15 years and an Effective Duration of 3.59 years.  On the same website, the 3-7 Year Treasury Bond ETF (IEI) has a Weighted Average Maturity of 4.70 years and an Effective Duration of 4.42 years.  Morningstar (www.morningstar.com) lists the Guggenheim Floating Rate Fund (GIFIX) has having an Average Maturity of 5.12 years and an Effective Duration of only 0.27.  The bonds within these portfolios have, on average, a relatively similar period of time until the principal is assumed to be paid as shown by the average maturities.  However, high yield bonds are implied to have greater insulation to changes in interest rates versus the 3-7 year Treasuries.  Floating rate, as the name implies, has the characteristic of periodically adjusting their interest rate payouts making them even less susceptible to rate changes than the other two.  An investor or fund manager may be comparing these potential investments in their due diligence process.  If they have an opinion on the direction and speed of possible interest rate changes, then duration would be an important factor.

Those newer to fixed income assessment often start with seeing the bond market as one entity, perhaps thinking “the bond market was up today…”, etc. That is certainly not the case.  The next step in learning more about fixed income is to see how various classes within the bond market actually differentiate themselves in price direction and volatility.  Maturity and Duration are simply two measures among many that investors explore when attempting to separate the parts that make up the bond market.


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