Franklin Templeton Investments posted a piece entitled, "Understanding Interest Rate Fluctuations". The "basic training" article says, "Because interest rate movements can significantly influence fixed income funds, this section is intended to help you understand the basics of how interest rates can affect a fund's share price and total return. What causes interest rates to rise and fall? The Federal Reserve Board (the Fed) controls the Federal funds target rate (Fed funds rate), which in turn influences the market for shorter-term securities. The Fed funds rate is the rate that banks charge other banks for overnight loans. The Fed closely monitors the economy and has the power to raise or lower the Fed funds rate to keep inflation in check or to help stimulate the economy." It also says, "Longer-term interest rates, as represented by yields of the 10- and 30-year Treasury bonds, are market-driven and tend to move in anticipation of changes in the economy and inflation. How do interest rates affect bond prices? Typically, bond prices and interest rates move in opposite directions. This means that when interest rates rise, bond prices tend to fall, and conversely, when interest rates decline, bond prices tend to rise." Franklin explains, "Here's why: Suppose you invest $1,000 in a 10-year U.S. Treasury bond with a 5% yield. That interest rate is fixed, even as prevailing interest rates change with economic conditions, especially the rate of inflation. After five years, you decide to sell the bond, but interest rates have risen and similar new bonds are now paying 6%. Obviously, no one wants to pay $1,000 for a bond yielding 5% when a higher-yielding bond costs the same. So the bond’s value has decreased."
