Bond Yields Are Up; Should We Worry?

It seems that every day there is a news article about why bond investors should be worried. Whether it's the threat of higher inflation or stronger growth or hints that the Fed may be thinking of reducing its bond buying programs, expectations are for interest rates to move higher. Ten-year Treasury yields are up by about half a percentage  point from early December, which is a significant move given the low starting point for yields. Since most investors buy bonds for the more stable part of their portfolios, rising interest rates can be unsettling. Should we worry?

The factors supporting our "lower for longer" viewpoint are still in place. The economy is still growing at a sluggish pace, inflation is still low and the Fed is still maintaining its accommodative policy. For all of 2012, the GDP growth rate was about 2% and the early estimate for Q4 2012 was a slight contraction in growth. With fiscal policy likely to tighten in 2013, it may be hard for the economy to generate stronger momentum. Based on the current Consumer Price Index, inflation is running at a 1.7% year-over-year pace, below the Fed's long-term target of 2%. Unemployment remains high at 7.9%, even though the pace of job growth last year was somewhat stronger than previously reported. Even with stronger job growth of about 180,000 per month, it would take until late 2014 to reach the Fed's target of 6.5%, according to the Federal Reserve Bank of Atlanta's model.

Higher interest rates are likely to be met with stronger demand. Investors searching for higher yielding investments have had few good choices for the past three or four years. They've had to reach for yield by moving out in maturity or down in credit quality. With the demographic shift of the baby boom generation moving into retirement, we believe there will be demand for bonds as interest rates move up, tempering the magnitude of increase, all else being equal. The number of people in the age group where income is an important investment goal is rising relative to those who usually favor growth from their investments.

Bottom line: Our outlook is for interest rates to remain in a low range this year, but with the potential to edge higher. Bond and bond fund holders should be aware of the risks of rising rates and make careful decisions about how to be positioned in fixed income when rates rise.

Source:  Charles Schwab

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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