low interest rates short/long term debt

I can’t get a definitive answer on this, in a low interest rate environment, do more people invest in long term debt than short term debt or vice versa??

things floating around in my head…

longer maturity means more IR risk, if everybody in the market moves for a certain type of debt this changes yields

I wouldn’t generalize, people will invest accross the yield curve based on their own expectations. I think the answer you’re looking for though is that investors will reduce their interest rate risk by buying shorter term debt, with the expectation that rates will rise and they will be able to reinvest their principal at a higher rate in the near future.

If I believed that interest rate were real high and would be going down, I’d buy long term bonds so that I can lock in that interest rate for the future. If I thought rates were going to rise, I’d keep my exposure to short term debt if I had to have an allocation to fixed income.

This is perhaps a backwards way of thinking about it, and I certainly could be wrong, but when rates are low, it would seem that there would be more borrowers looking to lock in lower rates for the long term. Every dollar of debt taken on must have an investor behind it, so it would be my guess that lower rates see increased total investment in long term debt, even though that means locking in lower returns for the investor. Sort of counter-intuitive, and perhaps something that breaks down on a more thorough analysis, but my initial reaction to your question was that the lower rate environment is going to lead to more long term borrowing.

Edit: This is of course, just newly issued debt.

Thanks for explaining yes this is what I had in mind

Also the scenario I’m thinking of is

  • interest rates record low for number of years
  • no rate rises expected in short term

So what do the majority of investors hold/do with their investment portfolios?

First I think my expectation is that rates have to rise eventually -> go long term debt but it all depends on when you think rates will rise so 3,4,5yr dated bonds…and if you really don’t have a clue then low duration bonds? something like that anyway

Well, typically in a low interset rate enviroment, we see increasing volume on equities and less of that in fixed securities. Bonds will be priced based on future expectations, in the sense that you’d find an upward yield curve starting from around the year at which rates are expected to go up. So no investor would be willing to buy a bond today that will give less yield beyond a point of expected change. Same thing happens in expectations of a coming recession, you’d find the yield curve temporarily, and irrationally downward sloping, where short term bonds are much cheaper than longer term bonds, because there is much more demand on the LT bonds which would pay high interset during a period of low ROIs.

MrSmart: Are you an academic?


The interest rate itself isn’t the driver as much as the shape of the curve and the expectations for how the curve will change.

Most fixed income portfolios are… portfolios. You will get multiple maturities in each portfolio. Yield, duration, and cash flow constraints will obviously affect the portfolio composition, but for your basic FI portfolio, the manager is paying much more attention to what the yield curve will do in the future than where it is at any given time.

Short term and long term fixed income are two very different strategies. Usually the decision to invest in one of those strategies by itself is driven by the purpose of the fixed income. Examples being cash management for short term, and long duration matching for liability focused investors.

If I had to say one or the other, and assuming the current rate environment, I would say more buy short term. Just because the risk of principal value is practically one sided, and the ability to reinvest with different yields. Again, that is more due to expectations for rising rates.

I read from time to time on a lot of different topics. But certinaly not an academic, I did pretty bad in school.

A lot of people have certain income levels they want to reach and can often ignore the risk they take to get those income levels. For example, in banking you see the majority of banks extending the terms and fixed rates due to competition and a desire to capture what little loan demand exists. I think the question can get very nuanced very fast, but I don’t know what the supply/demand answer looks like for an econ class.

Lots of demand, in Canada anyway, on the long end of the curve is insurers and pension funds immunising long term liabilities. Some of the demand across the curve is actually business driven and not so interest rate dependant. I imagine the same is true to the south, but I have no direct experience. When I was raising money in treasury, the buyers of a 10 year bond (lots of funds) were of a completely different composition to the guys we saw playing in the 30 or 40 year space (DB pension plans + insurers). There is certain demand inherent in the long end just due to insurance and insurance like products. The insurers just adjust their pricing to reflect market yields, they don’t shift their purchases down the curve.

Duration and Convexity young pups. Learn it.

Its gaining popularity, but since most corporate plans in the states are somewhere between 80-90% funded, plans are still investing in agg or intermediate and waiting for rates to rise, thinking that the duration mismatch will put them above 100% in the next few years. They’ve been waiting for a while now…

It really seems to depend.

Your basic exposure to bonds tends to be driven either by your expected liabilities or your desire for diversification. From there you might tilt your exposure based on a number of scenarios, but your basic exposure is set by these things. If you are just diversifying, then you might find that short term interest rates are correlated with equities in a different way from long term interest rates, so it’s possible that you treat the short, mid, and long ends of the curves as separate sub-asset classes. If you are neutralizing liabilities, then your structure is pretty much determined by those liabilities and your willingness to risk departing from that structure to grab some extra basis points.

So yeah, in a low interest rate environment, it generally doesn’t make a lot of sense to take on much interest rate risk, particularly since low yields mean long bonds have much higher duration than they would ad higher yields. Nonetheless, as people get sick of earning 10 bps on t-bills, many will start to reach for yield by extending maturities when they can’t take it anymore.

We haven’t really had long-term rising interest rates in the US in over a generation, so it will be interesting to see what happens as rates start to creep up. People who have a “buy the dips” mentality in terms of prices and for whom that has worked out nicely in the past will presumably keep at it until it doesn’t work anymore. It’s also true that once long-end rates get higher, some buyers who had been afraid of the interest rate risk will start to feel that there is more appropriate compensation.

So my answer is that (in terms of how you tilt your overall exposure) low interest rates tend to concentrate people at the short end of the curve, but after a while they can’t stand the pain any more and people start searching/reaching for yield. But it’s really higher long rates that will increase demand for the long end. In order to get there, rates have to rise, or the view of equities as an alternative has to be truly dismal.

^ But that increased demand in the long end would drive down yields, creating lower demand. Which would cause yields to rise… Oh man, my head hurts.

I wouldn’t consider 20 somewhat years as generation. No sound person is going to hold long term bonds in an inflationary, high interest rate environment. They wouldn’t be bidding for bonds, they would be dumping them. And ‘reaching for yield’ isn’t the reason rates are going up.

Yes, but one dynamic precedes the other. Typically the event that happens first dominates, even if the one that happens later dampens the effect (sometimes dramatically).

All the cool people know jerk as well

The thing you are forgetting is that rates don’t immediately rise. Where you go on the yield curve has a lot to do with how long you think it’ll stay low.

Rates can spike (1994) or they can be managed upwards by the fed. So rates do immediately rise at times, though those times are by definition unpredictable (if they could be predicted, the yield curve would reflect that in its shape).

The shape of the yield curve incorporates expectations of that timing (along with other things). Yes, you might position yourself along the yield curve somewhere else, but only if you are confident that you have better knowledge of when those gradual rate rises will happen than the market as a whole. And remember that when you are in the bond market, you tend to be competing not with mom and pop investors, but other professionals.