# Fixed-income investment in a low interest-rate environment

From an investment perspective, it seems to me that a low interest-rate environment can yield to some relatively "un-risky" profits.

As the interest-rate can barely go lower, we now it should rise again at some point (take for instance the recent interest-rate hike in the US).

In this case, what would be the corresponding investment vehicle/product to invest in? My guess would be to just short-sell positions in bonds, as an interest-rate rise corresponds to a decrease of bond prices, but this seems too obvious.

Am I missing something, for instance that short-selling of bonds is not permitted?

I also would push back some against your view that interest rates must somehow rise. Nevertheless, to speculate on future moves in interest rates investors have many products at their disposal, such as outright shorting bonds, selling Eurodollar futures, or selling interest rate swaps (paying fixed), to name a few.

You are right to be hesitant about there being free money on the table. The key hurdle is that the prices for many of these products already reflect investors' expectations that rates will rise. Take interest rate swaps, for example. I have attached a screenshot from a Bloomberg Terminal's USSW screen that displays different market rates.

The 10-year swap rate is quoted at 3.241%. If you are not familiar with swaps, basically two parties are agreeing to switch fixed and floating cash flows on an agreed notional value. Let's say the notional is \$100. With today's price, you can agree to either pay fixed coupons of 3.241% (so \$3.24) a year for the next 10 years, or receive USD 3M LIBOR (currently 2.478%). The benefit of the receiving the floating side is that the floating rate you get can go up as LIBOR increases. The benefit of the receiving fixed is that the rate you receive cannot go down.

If you wanted to profit off of increasing interest rates, then you would want to pay fixed and receive floating (since you thought the floating would go up). Notice, however, that at the start you would be paying 3.241% and only receiving 2.478%, so cash would be leaving your pocket, i.e. the trade has a negative carry. Not only would you need rates to go up to make money, but they need to go up enough to overcome all this money you lose in the meantime. This negative carry reflects investors' expectations that rates will go up over the next 10 years.

Shorting bonds (particularly long-duration) would expose you to a similar negative carry position. To borrow bonds, you would need to pay a form of borrow fee (most likely through charging a lower repo rate than the GC rate, see more special in repo market). Furthermore, you would also need to pay the coupons of the bonds you have shorted to their original holders. So once again, you might have to bleed a couple percent a year to keep this trade on. Even if rates go up, you might still lose money if they don't go up enough.

The bearish rate expectations already priced into the market and the costs of implementing shorts make it so you can still lose money on your trade if rates do not go up as much as you think or do not go up fast enough.

Your assumption that low interest rates will "eventually" have to rise is not warranted.

Indeed, we are currently witnessing prolonged periods of low interest rates that do not obviously seem to be coming to an end.

Example 1. For 7 years, the US FOMC's target federal funds range remained unchanged at 0–0.25% (from Dec 2008 through Dec 2015). From Dec 2015 through Oct 2018, there have been 8 increases so that it is now 2.00-2.25%. But even after 8 increases, this rate range remains historically low.

Example 2. A more dramatic example is the case of Japan, where the 10-year government bond yield has remained closed to 0% for two decades now (and indeed is under 0% now).

You predict that since interest rates are so low now, they must rise. You might very well turn out to be correct, but this is hardly a certainty and there are many others taking the opposite bet.

• Thanks for your answer, which I completely agree. However, my question is more about which fixed-income product to invest in should you expect interest rates to rise. Oct 23 '18 at 2:55
• You should rewrite your question more clearly then. As it stands, your focus seems to be on whether we can safely assume interest rates will rise -- "it seems to me that a low interest-rate environment can yield to some relatively "un-risky" profits"; "it should rise again at some point"; "Hence, wouldn't it be so easy to bet on it?"
– user18
Oct 23 '18 at 3:14
• It was more of a rhetorical question than the real question, which is In this case, what would be the corresponding investment vehicle/product to invest in? and matches the title of my question. Anyway, I have just deleted this rhetorical question to avoid confusion. Oct 23 '18 at 3:23

NOTE: I realized afterwards that the OP is asking about what vehicle/product to invest in in correspondence to an expected rise in interest rates, whereas my answer addresses situations in which either A)interest rates do not rise or B)OP wishes to take advantage of low interest rates before they rise again. However, I am hesitant to delete the answer since deleting answers is frowned upon. Please keep in mind the above when reading the answer below.

Fixed rate bonds are definitely an idea, especially if you can get fixed-rate loans at low interest.

Also, I don't know if this is applicable to where you live, but this is what a lot of people do in Japan and Korea: invest in real estate. Because the interest is so low, it's easy to take out a low-interest fixed-rate loan to purchase a second home/apartment and rent it out for fixed-income. What people will generally do in this case, assuming they have sufficient income, is pay off their loans for the first home in 20~25 years, then use that home as collateral to obtain an even lower interest rate for the purchase of the second home.

What makes this uniquely advantageous in these countries as opposed to, say, the US, is that because the interest is so low, monthly payments are usually what their rent would have been anyway, or even lower in some cases. A middle-class single income family, or a family with two working class jobs should be able to handle it without too much difficulty. I can't say the same for the US.

By the time they are finished paying off the second home, they are ready to retire and now have a home to live in plus fixed-income from the rent generated from the second home.

This has become less feasible in Korea in recent decades due to severe inflation of real estate prices, but in Japan a significant factor in determining property value is earthquake related variables, which helps to keep property prices down and affordable for buyers, relatively speaking.

• Thanks for the edit note! Btw, what is an OP?? Oct 23 '18 at 6:24
• OP is short for "Original Poster". Oct 23 '18 at 6:38