Every prediction is correct... at some point in the future. However, there are economical indicators that would be considered teaching points if a financial crisis were to occur at any point in the next two to five years:

  1. Government indebtedness: Traditional safe heaven economies, such as the US, UK, Canada and France have a debt-to-GDP ratio well over 100 percent, and the case of Japan, reaching 250 percent. In the US deficits are surpassing the $1 trillion mark, thanks to impossible non-discretionary social programs at the time of the baby boomers' retirement age, as well as recently passed tax cuts. Debt auctions by the US Treasury have been slowly increasing and being met with mostly lukewarm enthusiasm, signaling future problems in refinancing. The CRFB estimates that interest spending will rise from $263 b. (1.4 percent of GDP) in 2017 to $965 b. (3.3 percent of GDP) in 2028. Depending on the relative health of the euro, and crowding effects in an expanding healthy private economy, interest rates above 3 percent could become the norm.

  2. Corporate overleverage: S&P warned of high corporate debt reaching levels difficult to offset even after the recently enacted tax cuts:

    Based on a global sample of 13,000 entities, the agency estimates that the proportion of highly leveraged corporates - those whose debt-to-earnings exceed 5x - stood at 37 percent in 2017, compared to 32 percent in 2007 before the global financial crisis. Over 2011-2017, global non-financial corporate debt grew by 15 percentage points to 96 percent of GDP.

Here's a telling chart created by Bloomberg:

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There is no need to invoke things like increase in margin trading, the long-running bull market, possible overheating of the housing market, or other random points to overfit the idea.

The question is

Is reducing exposure to bonds a good idea to hedge against (likely?) hikes in interest rates in the next few years? I see the economy healthy overall, with employment at near capacity, wages slowly inching higher, and personal consumption and indebtedness in better shape than in 2008, so holding passive mutual funds in stocks with broad exposure still seems like the wisest route. A minimal gold hedge is already factored in.

I know you can look into futures contracts, ETN with inverse returns to government debt, CDS or other financial alchemy, but I like it simple, and don't know much.

  • 1
    I'm a bit confused by your question. If you "see the economy healthy overall" and that "holding passive mutual funds in stocks with broad exposure still seems like the wisest route" then all of the debt concerns in the first three paragraphs are not as dire as presented and for those reasons, you should have more equity exposure. Hedging against rate hikes is a more sophisticated strategy and if hikes are a concern, reduce bond exposure or take on floating rate securities. And don't count on gold. Sometimes it correlates, sometimes not. Commented Jun 3, 2018 at 22:49
  • @BobBaerker Yes, the statement on gold is preemptive. My vision of the economy comes from the same sources available to the public at large. Black swans are always lurking, and heralding indicators are only evident retrospectively. I'm sure everyone would agree that debt is a concern for Western gov'ts. But let me confirm... You are basically saying that the strategy proposed (Bogle mutuals and reduced bonds) is sound? Commented Jun 3, 2018 at 22:54
  • If your optimistic assessment of economic conditions is correct and there are no geopolitical shocks, Black Swan surprises, etc. then of course the strategy of investing in Bogle mutuals and reduced bonds is sound. If the unexpected comes to pass then not so much... or worse. Commented Jun 4, 2018 at 0:47
  • I'm don't know what you mean by gold is preemptive. Gold correlation to interest rates is totally unreliable. For example,during 2004-07, gold rose $315 while the 10 yr rose 56 BP and the FF rose 425 BP. In early 2008, gold rose $287 while the 10 yr dropped 100 BP and the FF dropped 250 BP. In late 2008, gold dropped $240 while the 10 yr rose 50 BP and the FF dropped another 125 BP. I chose these data points based on Fed Fund movement. So where's the pattern in any of that, worthy of betting on? With gold, other events factor in as well, not just interest rates. Commented Jun 4, 2018 at 0:48
  • @BobBaerker I wanted to avoid talking about gold completely - I know there is some work behind holding some gold, as proposed by Mankiw, but whenever inflation is brought up, I fear a tangent on gold, etc. Commented Jun 4, 2018 at 0:52

1 Answer 1


Reducing your investments in bonds would be reducing your exposure, not hedging it. Hedging an exposure is the act of taking positions which will benefit when this position is losing and vice versa.

Is reducing exposure to bonds a good idea to hedge against (likely?) hikes in interest rates in the next few years?

To answer your question, as said above this would not be a hedge so it can't be evaluated as a good or bad hedge. Let's play the game though, is it a good idea ? Well, it would be a good idea if you happen to be right. The problem is that we, mere mortals, are notably bad at predicting the future. Your analysis may be good (or not) but the results could be far from those you expect. The general advice given to neophytes, and also just to most people, is to diversify and not try to time the market (which is essentially what you are trying to do on the long term by adjusting your composition). I will assume that if you reduce your exposure to bonds, it would be in favour of stocks. If stocks nosedive and bonds do not, you just exposed yourself to a bigger loss.

  • I like the clarity of your exposition, and the main point (hedge versus exposure) is now apparent. But can you mention something about hedging against an increase in interest rates without going to pro with fancy instruments? Commented Jun 3, 2018 at 23:21
  • @Toni to be quite honest, I am not very well versed in the fixed income market. Institutional investors can use interest rate swaps and CDS, depending on the specific hedge they need. However, to my knowledge neither is available to individual investors. Another option would be to short some bonds so that a hike in rates would actually benefit your positions, however this can be risky. From a quick glance at results from a google search, it seems hedging of bonds is centered around duration (sort of the average of times until receiving coupons) which is definitely not for neophytes.
    – ApplePie
    Commented Jun 3, 2018 at 23:27
  • Hedge versus exposure is what I was referring in my comment further up the page. Hedging has various levels of complexity and sophistication. For a number of reasons, swaps are not for the everyday Joe. Shorting bonds is problematic because the spreads tend to be wide. An easier way might be shorting a treasury ETF or buying an inverse treasury ETF. For example, TLT and TBD. They come in various duration. Be aware that you'll pay out the dividend so it can be a good idea to dance around ex-div dates. Or if you want to limit risk exposure, they offer options. Again, more complex. Commented Jun 4, 2018 at 1:00
  • Since hedging takes a position which will benefit when the position hedged loses and vice versa meaning it will lose when the position hedges does well, what is the point of hedging in the first place versus just reducing exposure? It seems like you can't win either way.
    – Andy
    Commented Feb 17, 2023 at 22:24
  • @Andy multiple reasons come to mind. 1) Investments often have multiple sources of risk, hedging can focus on a single source and leave the rest unhedged (e.g. hedge interest rate risk but not credit risk) 2) maybe you're obligated to keep the asset in your books and want some insurance against it taking a loss 3) maybe the asset is part of your core business (e.g. wheat) and you just want to reduce fluctuations on the price and fix it. etc
    – ApplePie
    Commented Feb 20, 2023 at 0:06

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