Government Bonds: Short Term Interest Rates

This type of chart is intended to predict bond prices based on government policies, using data on monetary policy available at the time. (See Investor Education > Conceptual Framework > Proprietary Indices for further explanation) Best Guesses as to the effect on markets are shown as red arrows embedded in the bond market index.
 
In each chart the bond market index is shown as the thick white line on the right hand axis. The main explanatory variable, short term interest rates, uses the left hand axis, shown as the thin yellow line. The left-had axis is inverted to compensate for interest rates and bond prices moving in opposite directions.
 
For comparability bond market indices have been rebased to set year-end 1994 at 100. Please note the differences between charts in the Bonds RouteMap and those for other RouteMaps. Since income is a major consideration for investment in bonds, bond market indices are shown as total return and not in terms of price only.
 
The selection of monetary variable depends on the user’s choice of Investor’s Perspective. Interest rates are useful in predicting bond prices in absolute terms, either from the Perspective of a Local Currency or Dollar Investor, but tend to have an opposite effect on the exchange rate, so limiting their usefulness for global comparisons. Therefore for the Global Investor’s Perspective only, real effective exchange rates are used instead. The series is expressed as a rate of change indicator.
 
This strategy works on the assumption that governments rarely make a change in policy all at once, but spread out over a number of intermediate steps, so the effects of a change create a trend over time that investors can exploit. However, in times of crisis this is not the case.
 
Owing to the conversion of legacy currencies into Euros, analysis is provided on a common bond market denominated in Euros, rather than for individual countries. Historical data is provided by creating synthetic GDP-weighted time-series for the component currencies, expressed in the European Currency Unit.
 
Buy signals are generated when interest rates begin to fall. Sell signals arise when the converse applies. Noise reduction methods have been employed to minimise the number of signals.
 This strategy has been of only marginal value when back-testing but has been helpful since it went live when this RouteMap was launched in 2000