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Interest Rates Are Climbing

In the U.S., we have lived through a period of unusually low interest rates over the past decade.  In response to the Global Financial Crisis of 2008, the U.S. Federal Reserve cut short term interest rates close to 0% for the almost a full decade.  Moreover, the Fed engaged in quantitative easing as well, buying bonds from the market in an attempt to lower interest rates on the longer end of the yield curve.  Accordingly, we have had extremely low interest rates for longer than most economists expected.

But we are now seeing rising interest rates, both for short term bonds and longer term bonds.  Just last week, the Fed raised the short-term reserve target rate to 2%.  The 10 Year U.S. Treasury bond recently rose above 3%.  It is currently yielding 3.07%.  The 3% number on the 10 Year bond is a big psychological marker for the markets.

Investors are not quite sure what to make of rising interest rates.  On one hand, we have been trained to associate low interest rates, and interest rate cuts, with high stock markets.  If the Fed is providing the stimulus of lower interest rates, then we have been conditioned to think that the stock market will rise.  And this has been largely true for more than 10 years now.

But rising rates can also be a good thing, when experienced under the right conditions.  Rising interest rates in our current environment are signaling that our economy is very healthy.  This is a great thing for the stock market and for risk assets.  The Fed is raising short-term rates because the U.S. economy is growing at a healthy clip.  Far from worrying about a potential recession, the Fed is raising rates out of fear of stoking inflation due to overly accommodative monetary conditions.

Long-term investors also gain an advantage with their bond positions as yields rise.  Instead of expecting 2-3% from high quality bonds in the past, investors can now look to the future and expect 3.5%+ from high quality bonds in their portfolio.  The rise in yields is a positive development for retirees and those close to retirement.

We continue to monitor bond yields closely.  While the recent rise in yields has been a positive development, we would grow more concerned if the Fed raised short term rates above long-term rates.  This is what is known as an inverted yield curve.  An inverted yield curve is a possibility over the next two years and something to monitor.  But as of now, we are welcoming the modest rise in interest rates.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in this material may not develop as predicted. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

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