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Fixed Income Investments and Rising Rates

Jason-RothThe market is currently pricing in a 92% probability the FOMC (Federal Open Market Committee) will elect to raise the overnight federal funds rate 25 basis points (one quarter of one percent) at their next meeting December 14th.  APCM is currently anticipating the December rate increase and probably two more in 2017.  The number of rate increases and when they occur will be determined by economic activity and the Federal Reserve’s anticipated rates of inflation.

What does this mean for fixed income investments?  As we know, there is an inverse relationship between bond prices and bond yields.  If rates rise the values of fixed income investments will fall (the opposite has been true as rates have fallen).  ‘One thing that investors need to understand about the high-quality, fixed-income market is that the United States market is dominated by institutional players who are often insensitive to the level of interest rates,’ say Pramod Atlure, co-manager of the Fidelity Total Bond exchange-traded fund.  They have been allocating funds to provide exposure to the fixed income markets and generally don’t flee as individual investors are apt to do.

The rates of shorter maturity fixed income securities are expected to rise faster with the Federal actions, but, because of their shorter terms, their prices will only be modestly impacted.  Securities with longer maturities will see the largest impact as there is not as much coupon cushion, and are most exposed, from a price perspective.

So, what is an investor to do?  We need to remember that we live in uncertain times and fixed income investments are intended to serve as ‘an anchor in a storm’.  Investors have an allocation to fixed income in their portfolio for a reason.  History has taught us that unanticipated events will occur; we just don’t know what they are or when they will happen.

Investing in quality fixed income mutual funds or a laddered fixed income portfolio will allow the fixed income portion of your portfolio to reprice and adjust as interest rates rise as well as serving as that ‘anchor in a storm’ when the unexpected does happen.

 

Jason Roth
Senior Vice President, Investments

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