Rising Interest Rates

Rising Interest Rates

By Nick Clay

On December 9th there was a story in the Wall Street Journal that discussed The Federal Reserve possibly removing the phrase “considerable time” from its policy statement regarding interest rates at next week’s FOMC (Federal Open Market Committee) meeting. This simple “suggestion” drove markets down 220 points early in the trading session in the form of a nice knee jerk reaction.

Fast forward to later in the day when one Fed speaker, Dennis Lockhart, offered up that the Fed was in “no rush” to start hiking rates…. And cue market come back for the day, only closing down 50 points.

Two knee jerk reactions from the market and it’s investors in one day, all over interest rates and the timing of increased rates. We saw this type of long(er) term reaction in the second half of 2013 when The Fed basically said that at some point rates would have to go higher, and bonds saw plenty of depreciation only to recover over the last 15-16 months. The chart below shows the severe decline in the Barclays Aggregate Bond Fund Index from May-September 2013.

chart

Somewhere in the middle ground of immediate interest rate increases and a lengthy time of gradual increases the central bank is inevitably going to start raising rates. With the global slowdown more of a concern and inflation currently out of the picture, most agree The Fed won’t rush or do anything drastic when it comes to raising rates, but we will most likely see an uptick in 2015.

If bonds continue to be a portion of your portfolio, there are certain areas of the bond market that have done well historically in periods of rising interest rates. The chart below from Lord Abbett & Co. shows the last seven periods of increasing interest rates of greater than 100 basis points (1%) in the 10 year U.S. Treasury Yield.

Book1.xlsx

1Citi Treasury Benchmark 10-Year Index. 2Barclays U.S. Aggregate Bond Index. 3BofA Merrill Lynch U.S. Corporate BBB-Rated 1-3 Year Index. 4BofA Merrill Lynch High Yield Master II Constrained Index. 5Credit Suisse Leveraged Loan Index. 6BofA Merrill Lynch All Convertibles All Qualities Index. 7S&P 500 Index.

Past performance is no guarantee of future results. Performance during other time periods may have been different or negative. Other indexes may not have performed in the same manner under similar conditions.

During periods of sharply rising Treasury yields, credit sensitive sectors of the bond market historically have done well, but keep in mind, past performance is not indicative of future performance. So, how should you position the bond portion of your portfolio? Our advice is to work with your financial advisor to help you make the appropriate changes (if any) to your portfolio; everyone is different with their investment needs and risk tolerance. I think we can all agree that at some point in the near future rates will start to increase, be prepared, and remember no knee jerk reactions!

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