Rising interest rates are creating new opportunities in fixed incomeNew market research from Fidelity’s Viewpoint Blog reveals that while there is a growing investor anxiety, there is also an opportunity in bonds for many people seeking income, principal protection, and diversification. Reprinted with permission. Visit here to learn more.
In the first half of 2022, the bull market in bond prices that had been running hard since 1982 fell to its knees. Since January, the Bloomberg Barclay’s US Aggregate Bond Index dropped 8.8%, its biggest decline in 4 decades. The major driver: investor anxiety that the Federal Reserve’s plan to fight inflation by raising interest rates would hurt bond prices. Higher interest rates typically mean lower bond prices and higher bond yields.
But investor angst may obscure the fact that the Fed’s plan to return rates to more historically normal levels may present an opportunity in bonds for many people seeking income, principal protection, and diversification in the second half of 2022 and beyond.
- The Federal Reserve is hiking interest rates, which is lowering bond prices and raising yields.
- Higher yields mean bonds can now play a more significant role in retirement income strategies than they have since the global financial crisis.
- Professional investment managers have the research, resources, and investment expertise necessary to identify opportunities and help manage the risks associated with bond investing in a rising rate environment.
Good News For Savers
For decades, retirees and other income-seekers could meet a significant chunk of their need for income simply by arranging low-risk government bonds of varying maturities in what is called a bond ladder. However, the historically low interest rates that the Fed has maintained since the global financial crisis have made this difficult. As Managing Director of Asset Allocation Research Lisa Emsbo-Mattingly puts it, “The Fed has been financially repressing savers, especially retirees.” Now, though, rising rates mean that retirees and savers may once again be able to earn attractive returns without taking much risk.
More Rate Hikes Coming Soon
Rates have already moved up significantly and Emsbo-Mattingly expects the Fed to raise the federal funds rate sharply and quickly this summer. Chairman Jerome Powell has said the Fed wants to bring inflation down without hurting economic growth and employment. If inflation comes down to the range where the Fed wants, real rates, which are yields minus the rate of inflation, could rise further into positive territory after being below zero for the past 2 years. This would help government bonds to once again be meaningful contributors to the total return investing strategies that many retirees and other savers rely on to supplement Social Security, pensions, and other sources of income.
A Brief Window For Yield-Seekers
Getting inflation under control is the focus of Fed policy in the months ahead, but the central bank also wants to make sure it has room to cut rates when the economy goes into recession, potentially in 2023. Rate cuts are the most powerful tools the Fed has to stimulate economic growth and the central bank wants to be able to make impactful cuts when necessary without resorting to the negative rates that central banks in Europe and Japan have adopted.
Powell has said he does not believe negative rates are appropriate for the US. That could mean that the opportunity to build low-risk bond ladders or other types of bond exposure at these levels into your income strategy may not be there if you wait too long.
While savers are set to benefit from the higher rates ahead, those who hold bonds to preserve capital and offset volatile stocks in their portfolios may also find opportunities if they’re willing to wait. One result of the end of the bond bull market is that prices of many bonds, especially high-quality corporate bonds, have become cheaper than what the issuing companies’ fundamentals would suggest they should trade at.
Portfolio manager Jeff Moore points out that credit quality for most investment-grade issuers remains high and risks of default are low, but prices have been pushed down by anxiety-driven selling. He’s taking the opportunity to bargain shop for high-quality bonds in the funds he manages and says he’s collecting the higher yields now while he waits for prices to rise in the future once the economy slows and the Fed begins cutting rates. “Bonds are self-healing and with higher yields you can get paid to wait for prices to recover,” says Moore.
History shows that bond markets rarely string together several down years in a row and there are reasons for price-oriented bond investors to feel hopeful that modestly better times are ahead.