ICI: What Happens When Rates Rise?
ICI writes "The Taper Tantrum - Take II" in a new "Viewpoint," which discusses "What happens to bond funds when rates rise?" The piece says, "Long-term interest rates in the United States have been on the rise since summer 2016 -- slowly creeping up from July through October, and then jumping after the presidential election. Thus far, the response from bond mutual fund investors has been subdued. Nevertheless, various commentators -- from the vice chairman of the Federal Reserve Board to the multinational Financial Stability Board -- have expressed concerns that bond fund investors may rush to redeem shares to avoid portfolio losses stemming from unexpected increases in interest rates. In a new research report -- "What Happens When Rates Rise? A Forecast of Bond Mutual Fund Flows Under a 2013 Taper Tantrum Interest Rate Scenario" -- I weigh those concerns by applying the experience of the 2013 "Taper Tantrum" to examine potential outflows from such funds and the outflows' impact on the broader bond markets in such an interest rate scenario. The bottom line? Even a repeat of 2013's "Taper Tantrum" -- one of the sharpest increases in long-term interest rates in recent US monetary history -- wouldn't be expected to trigger destabilizing outflows from bond mutual funds or force "fire sales" of bonds by those funds. In fact, bond mutual funds would be expected to be net buyers of bonds in some categories." The article adds, "As a thought experiment, we forecast how bond mutual fund investors might react to a sharp, unexpected change in monetary policy.... Views are mixed, though, on how quickly and by how much the Fed may ramp up the federal funds rate going forward. Most observers expect the Fed to increase short-term interest rates slowly yet steadily over many months, to minimize the likelihood of harmful outcomes in financial markets and the real economy. But what if the Fed instead tightened monetary policy sharply and unexpectedly? Would bond fund investors react more strongly than in the past several months?"
