What Does The Fed Mean for Your Bond Portfolio? Not as Much as You Might Think
By Peter Cook
Since at least 2010, people have been predicting higher interest rates. Now, finally, the Federal Reserve (the Fed) has been steadily raising its benchmark interest rate. But contrary to what you might expect, this does not necessarily mean that we are in a bear market for all interest rates. In fact, there have been several periods when the Fed consistently raised its benchmark rate and long-term interest rates actually fell.
For example:
From 2004 to 2006 the Fed raised its benchmark interest rate from 1 percent to 5 percent while over the same period, long-term bond yields actually declined.
From 1994 to 1995 the Fed raised its benchmark interest rate from 4.75 percent to 6 percent, meanwhile 10-year bond yields declined from 7.75% to 6.25%.
And conversely, in 1991 to 1993 the Fed cut rates from 7 percent to 3 percent, during which long-term rates remained elevated and at some points even increased.
This is worth noting because many investors mistakenly structure their portfolios based on what they hear people saying about interest rates or what the Fed might be doing.
For instance, in the aftermath of the great financial crisis many pundits were claiming that with the economy recovering, interest rates were sure to go higher. What actually happened was that the 10-year treasury bond rates fell from 3.75% to 2.5%. Thus, investors who took this advice and positioned their portfolios with the expectation of rising interest rates in 2010 would have missed out on at least seven years of higher current yield, not to mention price appreciation.
The takeaway is that interest rates are more than just the Federal Reserve. Though the Fed does play an important role, the bond market is large, complex and difficult to predict. As such, an intelligent portfolio allocation, and not the intuition of pundits, is the investor’s best hope for maximizing wealth.
Peter Cook, CFA®, CFP® is the founder and manager of WhiteTree Investment Management, a registered investment advisor located in Mount Kisco, NY. He previously held positions TD Securities and Credit Suisse in the Fixed Income and Private Banking divisions.
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