Interest Rates Jump in 2013

February 08, 2013 | Greg Leonberger, FSA, EA, MAAA, FCA, Director of Research, Managing Partner

This week’s chart is relatively straightforward but reflects some potentially powerful messages for institutional investors. As plainly seen from the chart, 2013 to date has seen a continued run-up in the equity markets (red line): as of February 7, the S&P 500 has returned 5.8% for the year. While this is good news for all investors, it is the jump in interest rates that holds more of a mixed message for investors.

Since the end of 2012, interest rates (as measured by the yield on the 10-year Treasury) have increased by about 22 basis points, a notable jump that led to losses for most core bond strategies. If the equity markets continue their upward trend, we expect further upward movements in interest rates, which will be dilutive for bond investors. Adding some exposure to floating rate bonds (such as bank loans) may help to offset these rate increases.

However, higher interest rates are not all bad news. Pension funds that report liabilities at market rates (primarily corporate plans) actually saw their funded ratios increase as a result of higher rates, given the relative mismatch between the durations of their assets and liabilities.