The Fed, Interest Rates, And Your Bond Portfolio
It’s a foregone conclusion in the markets that the Federal Reserve will raise short term interest rates on Wednesday. But more importantly, investors will be looking for hints for future rate increases.
Why is this so important? The consensus view is for 2-3 Fed increases this year, but anchoring into this expectation comes with risks. For example, in 1994 the Fed surprised investors by increasing rates 6 times, resulting in a 3% loss for bonds that year. Of course, bonds recovered in following years, thanks largely to the long-term trend of falling interest rates since 1981.
(Interestingly, only today’s 98-year-olds, who were 21 in 1940, will remember the start of the previous long-term bear market in bonds. In other words, today’s bond investors have little to no experience with the headwinds of rising rates.)
Experts and forecasters have been calling for higher interest rates for almost a decade now. And interest rates have only grinded lower. Even today you can find a bond guru here or there forecasting even lower rates.
So, what’s an investor to do? How to navigate the uncertainty in the bond markets? First, don’t base your plan on outsmarting the market, because very, very few have the ability to consistently do so. Instead, put the power of markets to your advantage. When certain parts of the yield curve offer higher yields than others, it signals that those bonds’ prices have dropped more than others. Put another way, the bond market is showing you which parts of the yield curve offer “buy low” opportunities.
In this approach, changes in yield curve direct one’s bond positioning. Think of this as a disciplined process for deploying the “buy low, sell high” philosophy that so many investors believe in yet few successfully execute.
Lastly, much like in 1994, there are shorter time periods in which this strategy doesn’t appear to be working. But over time, few would argue that a “buy low, sell high” hasn’t delivered good results across many asset classes. The hardest part is often not the investments, but the investors themselves.