A Timely Client Question

Doug Drabik discusses fixed income market conditions and offers insight for bond investors.

“The Fed is going to move (hike the Fed Fund rate) six or seven times. Should I sell now?” The short answer is “no”. There is a lot behind the reply. It comes as no surprise that investor responses can be impulsive as we live in a world of instant gratification and media persuasion. Market sentiment can be a powerful and persuasive influencer. Keep in mind, the purpose of your fixed income holdings can impel your action. The question is: what are the implications of the Fed’s actions to raise rates across the curve, moving prices down. Theoretically, an investor is selling with prices high, and purchasing in the future when higher interest rates push prices lower.

First and foremost, recall why you have allocated money to fixed income. In many cases, it is probable that bonds are meant to protect principal and secondarily provide income and cash flow to the portfolio. Speculating on the market and attempting to benefit from timing the market are often left to other asset allocations. Selling bonds because you think interest rates are going higher is speculating on a future event. If you hold onto a bond until maturity, market volatility does not affect your principal, income or cash flow.

Second, the market has already priced in eight plus Fed hikes through 2022. The market is forward thinking and has been responsive to the Fed’s transparency anticipating the upcoming rate hikes. This Bloomberg chart shows that Fed Funds futures are pricing in an implied Fed Funds rate of 2.48% by year’s end.

Finally, history has shown that the entire Treasury curve does not necessarily follow in sync with Fed hikes. When the Fed raises rates, they are raising the Fed Funds rate (an overnight rate). Fed hikes have historically tended to flatten the yield curve (tighten the spread between short term interest rates and longer term interest rates). Note the last cycle of Fed hikes and how the entire curve reacted.

Interest rates have significantly increased while, at the same time, corporate spreads and municipal yields have gone higher. With the Fed well on their way to tighten policy, it may be an opportune time to shore up fixed income holdings and begin to unwind the overweight growth allocation towards a more balanced weighting of both growth and principal protection asset allocation and take advantage of the attractive, higher individual bond yields.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

Stocks are appropriate for investors who have a more aggressive investment objective, since they fluctuate in value and involve risks including the possible loss of capital. Dividends will fluctuate and are not guaranteed. Prior to making an investment decision, please consult with your financial advisor about your individual situation.