Beware of investing in bonds during rising interest rates environment?

Bond yields have increased significantly the past few months as central banks all over the world are raising interest rates. Banks are now offering fixed deposit rates at more than 2% again and another attractive investment which people see are bonds where the yield has increased significantly. The SGS bonds, which are issued by the Singapore government has yields of close to 3% for its 2, 5, 10, 20 and 30 years bond. This is 3x more than then average of 1% just 1 year ago. 

Looking at the chart below of a 5 and 10 year SGS bond, we can see that the yield has increased significantly from 2020 to now which corresponds to the increase in interest rates around the world. Is this a good time to invest into bonds now? 

5 and 10 year SGS Bond Yield 2019-2022

Unfortunately, bonds can be the worse to invest during rising interest rates environment. When you invest into a bond, the yield (coupon) you get is fixed. For example if you invest in a bond with yield of 3% now, this 3% will be given to you regardless if interest rates continue to increase later. The most scary thing is when interest rates continue to increase later, bond prices will drop where you will see a loss in your investment portfolio. When bond yield increases, bond prices will drop as it is inversely correlated. This is evident as seen in the chart below where interest rates rose from 2020 to 2022 while bond prices started to drop from 2020 onwards. 

5 and 10 year SGS bond price 2019-2022

If you're planning to sell your bond in the short term, it wouldn't be advisable to invest in bonds now as the US is expected to increase interest rates even more for the rest of this year as what the Fed has announced recently. The Fed just raised another 75 basis points on 28 Jul 22 and has announced that another unusually large hike may come in September 22. This will cause bond yield to go up even more and bond prices to come down significantly. 

If you're planning to hold the bond for long term and are buying 5, 10, 20 or 30 years bonds, then it may be a good choice as you get to lock in higher interest rates now and by the time you redeem the bond more than 5 years later, bond prices may have even risen significantly due to interest rates are low again 5 years later. That being said, nobody will be able to predict how long interest rates will stay high or when interest rates will come down. 

Bond prices are trading at below 100 now which is lower than its face value and may represent an opportunity for the long term. Once interest rates stabilise and start to fall again, bond prices will go back up to 100 or even above 100 and at that time, investors who bought the bond below its face value will continue to enjoy the locked in high interest rate plus the capital gains from the bond price increase. This is if you're buying a long term bond and willing to hold on to the bond till its value goes back to par. 

Rising interest rates present quite a lot of opportunities for savers who have cash on hand to invest in high yielding safe assets. If we know how to take advantage of the opportunities which is presented to us, we will end up better in life in the future. 

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Is a Recession Coming?

Just as we thought all is well after COVID and economies around the world start to recover, we are hearing the word recession now. Is this really happening just as we went thorough 2 years of COVID where recession just happened?

Recession just happened during COVID where jobs were lost which led to unemployment going up. Singapore's GDP growth rate became negative in the period of March to June 2020. We would remember that many people lost their jobs, salaries were cut and it was a painful period. Fast forward 2 years later, we are seeing another phenomenon. Inflation went up a lot due to supply chain shocks caused by the Russian Ukraine war. In fact, US inflation rose to 9.1% in June 2022 which is the highest increase in 40 years since the 1980s. 

Inflation is a tricky situation to deal with. With prices increasing, wages need to keep up if not in the long run, the people in the country will suffer with real wage growth stagnating. Real wage growth is the increase in wages minus inflation growth. If the increase in wages is 3% and inflation is also 3%, then real wage growth is 0%. In essence, our wage did not go up at all considering inflation is the same increase. This is true because if our wages don't keep up with inflation, we will feel the impact of the rising cost of living and will be unhappy. 

As workers expect higher wage growth, companies will feel the cost pressure as they also increase the salary of their workers to keep up with market competition. You can see that in Singapore, the public service is leading by example by adjusting salaries to keep up with inflation. Private companies will also start to adjust their salaries so that they can attract and retain talents. As companies face the cost pressure of workers salaries increase, they will adjust the price of their goods and this in turn will affect consumers in the form of higher prices of goods we buy or consume. Coupled with increased prices all over the world due to the Ukraine war etc, we have a situation of huge inflation growth we see now and may even go higher in the next couple of months. 

Now, governments all over the world know this is not sustainable so they will come in and use their monetary policy tools to stabilise the situation. Most countries have an interest rate policy where they increase interest rates to combat high inflation. By increasing interest rates, it becomes harder for individuals and companies to borrow and thus reduce consumption and demand as a whole. This slows down growth and if not done properly, will trigger a recession event where companies start to retrench staff. We have seen this happening in many prominent companies such as Shopee, Tesla and even Google is slowing hiring. Many tech companies such as Shopee rely on investors funds and debt to fund their operations as they are primarily loss making and in expansion mode. With interest rates so high, it doesn't make sense to borrow so much now and thus they are slowing down their operations and keeping cost low. 

We might see a recession coming and jobs might be loss again. If interest rates keep rising and shows no sign of slowing down, we might be hit even harder as borrowers default on their loans if they are unable to pay the higher amount of installment due to higher interest rates. Good news is for the general public who do not have too much loans, we should see prices coming down thereafter. Let's see how the situation evolves as we live in unprecedented times now.