ECONOMIC RISKS TO BONDS

Bond investments are heavily influenced by economic conditions; the two major forces are interest rates and inflation. Interest rates pose risk because if you were to own a bond that was issued before a hike in interest rates, you are liable to lose money if you sell the bond before maturity, due to the fact that the price will be lower than par value. Interest rate fluctuations make existing bonds holders uneasy as would be investors, and traders would seek bonds that pay higher interest.

It is also fair to say that when interest rates are low, investors prefer stocks to bonds seeking higher returns, which in turn can depress bond markets. Inflation is another economic risk, because rising inflation will erode the buying power of any interest payments, and the value of the principle. Inflation tends to be more erosive when you hold longer term fixed income investments, because the longer you hold the more likely that inflation will erode value;

Therefore, it is important to know that bonds are considered ‘counter cyclical’ securities as the diagram below highlights: