Interest Rate Projections & Treasury Prices 0 comments Jan 19, 2010 05:56 PM | about stocks: SHY, IEF * Font Size: * Print * Email * TweetThis Bloomberg reported on January 19 that the consensus view of prospective interest rates by 12/31/2010 for the two-year Treasuries and ten-year Treasuries. If those predictions come true, what are the price and total return implications for Treasuries? The 12/31/2010 rate predictions are for reduction in the steepness of the yield curve (the shorter end rising more than the longer end): * 2-Yr Treas: 1.90% (current rate 0.93%) * 10-Yr Treas: 4.20% (current rate 3.73%). The predicted changes in rates are therefore: * 2-Yr Treas: 0.97% * 10-Yr Treas: 0.47%. The current duration of those instruments is 1.99 years for the 2-year and 8.53 years for the 10-year. Since the duration indicates the percent by which a non-callable, non-prepayable bond is expected to change for a 1% shift in the interest rate for bonds of that maturity, the rate predictions suggest that: * the 2-year Treasury will decline by about 1.93% (1.99 x 0.97) * the 10-year Treasury will decline by about 4.00% (8.53 x 0.47). Combining the current yield with the duration based price change indication using consensus rate predictions, both Treasuries would have a negative total return for the year, with the 2-year suffering a larger loss than the 10-year: * perhaps a negative 1.00% total return for the 2-year * perhaps a negative 0.27% total return for the 10-year. Of course, the consensus may not be correct, as it often is not, and Treasury rates are highly likely to be driven by events as well as by incremental changes in the economy. So long as the Dollar is a haven in times of great international fear, if some nasty world event or condition arises, Treasuries would likely rise in price. However, if the world economy continues to improve and event shock does not occur, rates have to rise sooner or later, in which case bond prices will adjust downward. The great bull run in bonds is probably at it, near, or just past its end. Goldman Sachs see rates lower than the consensus and lower than today, while Morgan Stanley sees rates higher than the consensus and today. Goldman sees the 2-year at 1.00% by 12/31, and Morgan Stanly sees the 2-year at 2.75%. Goldman sees the 10-year at 3.25%. If Goldman is correct, the Treasuries will rise in price. If Morgan Stanley is correct, the Treasuries will fall in price more than the consensus would suggest. Two ETFs that generally relate to the 2-year and 10-year Treasuries are: * SHY duration 1.89 years, average maturity 1.94 years, SEC yield 0.80% * IEF duration 7.19 years, average maturity 8.58 years, SEC yield 3.42%. Compliance Disclosure: We do not currently own any funds discussed in this article. We are a fee-only investment advisor, and are compensated only by our clients. We do not sell securities, and do not receive any form of revenue or incentive from any source other than directly from clients. We are not affiliated with any securities dealer, any fund, any fund sponsor or any company issuer of any security. This report is for informational purposes only, and is not personal investment advice to any specific person for any particular purpose. We utilize information sources that we believe to be reliable, but do not warrant the accuracy of those sources or our analysis. Past performance is no guarantee of future performance. Do not rely solely on this research report when making an investment decision. Other factors may be important too. Consider seeking professional advice before implementing your portfolio ideas. Richard Shaw QVM Group LLC Disclosure: Compliance Disclosure: We do not currently own any funds discussed in this article. We are a fee-only investment advisor, and are compensated only by our clients. We do not sell securities, and do not receive any form of revenue or incentive from any source other than directly from clients. We are not affiliated with any securities dealer, any fund, any fund sponsor or any company issuer of any security. This report is for informational purposes only, and is not personal investment advice to any specific person for any particular purpose. We utilize information sources that we believe to be reliable, but do not warrant the accuracy of those sources or our analysis. Past performance is no guarantee of future performance. Do not rely solely on this research report when making an investment decision. Other factors may be important too. Consider seeking professional advice before implementing your portfolio ideas. Richard Shaw QVM Group LLC Stocks: SHY, IEF