Vanguard Australia - Low yields and rising rates concerns: the implications for bond market investors

Vanguard Research

Executive Summary. The global fall in interest rates to very low levels post the 2008 financial crisis has provided fixed income investors with returns from rising bond prices that are significantly above average. Fear that “bond market bubble” conditions exist, and that the bubble could burst if yields start to rise rapidly, has become a frequent discussion topic amongst investors.

In this paper, first we re-address the role of bonds and their important diversifying characteristics within a portfolio of growth and defensive assets. We discuss how the maths of bonds influence returns after an interest rate rise and the difference in the performance dynamics of bond markets and equity markets, as well as the diversifying benefits of bonds in a portfolio with growth assets. We show the likely outcome from an unexpected interest rate shock on a bond portfolio. We also analyse the strength of forward yields as a predictor of the future direction of interest rates with respect to the short end. And finally, we show the
difficulties involved in trying to predict short term movements in interest rates and thus how counterproductive it could be to engage in investment strategies based on strong views about the direction of interest rates.

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