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Randy Frederick, managing director of trading and derivatives at Schwab

Randy Frederick

Vice President of Trading and Derivatives

Randy focuses primarily on client education and market analysis. He is a frequent guest on CNBC and Bloomberg TV.

Get the latest market commentary and join the conversation.

Three Fed Hikes Seen in 2017: How Should Bond Investors Respond?

March 16, 2017


RANDY FREDERICK: On Wednesday, the Federal Reserve raised interest rates by a quarter-point for the second time in only three months. Kathy Jones, Schwab’s chief fixed income Strategist, joins me for the March 16th Schwab Market Snapshot to discuss this change, and what it might mean for bond investors. Welcome back, Kathy.

KATHY JONES: Thanks for having me, Randy.

RANDY: So, Kathy, I think almost everyone was expecting this interest rate hike. And yet equities rallied, and from your perspective, even more interesting, why did bond yields fall?

KATHY: Well, I think there was some relief when we found out that the Fed was signaling only three rate hikes in 2017, rather than four, which had been a fear that had gone through the market recently. So sticking with that three rate hikes this year, including the one that we just had, lets the market know that there’s not going to be a rapid rate of increase in interest rates. And, also, Fed Chair Yellen, in her press conference, emphasized the gradual approach that the Fed was going to continue to take in terms of tightening monetary policy, and that was also a relief to the market.

RANDY: Well, now, if there’s one thing that just about everyone understands about the bond market it’s that as interest rates go up, bond prices go down, and vice versa. So what does this hike in interest rates mean to bond investors, especially if we might get two more hikes later this year?

KATHY: Well, I think one of the things to keep in mind is when interest rates go up—yes, bond prices go down—but longer-term bond prices go down more than short-term bond prices. So if you’re concerned about the impact of rising rates on your portfolio, one thing you can do is you can bring the average maturity or duration of your bonds a little bit lower. And that should help reduce some of the volatility in your portfolio. Now, that doesn’t mean selling all your long-term bonds, but it could mean just adding some shorter-term bonds or perhaps some floating rate notes to the portfolio to reduce that average, and that can help dampen some of that volatility that we expect going forward.

Also, keep in mind that every cycle is a little bit different when the Fed is hiking rates. There’s no rule of thumb. There’s no absolute pattern that it follows. And so it’s very difficult to predict where in time or at what yield long-term rates will peak. So it might be to your benefit to think about, say, a bond ladder, where you’re spreading the maturities out over time. It helps get you out of the position of trying to time the market.

And the last thing I would think about is typically when the Fed is raising rates, it’s because inflation is rising. So one way you can help mitigate the impact of rising inflation is to own some Treasury Inflation-Protected Securities. Right now, that market is priced for 2% inflation over 10 years. So if you think that inflation could be higher than that, TIPS should do better than regular treasury bonds in that environment.

RANDY: That seems like really good advice, Kathy. That’s about all the time we have for today. Thank you so much for your perspective.

If you want to read more from Kathy you can do that in the Insights and Fixed Income section of Schwab.com. You can follow Kathy on Twitter @KathyJones, and, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Treasury Inflation Protected Securities (TIPS) are inflation-linked securities issued by the US Government whose principal value is adjusted periodically in accordance with the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate, as it is based upon the principal value of the bond. It may fluctuate up or down. Repayment at maturity is guaranteed by the US Government and may be adjusted for inflation to become the greater of the original face amount at issuance or that face amount plus an adjustment for inflation.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

While the market value of a floating rate note is relatively insensitive to changes in interest rates, the income received is highly dependent upon the level of the reference rate over the life of the investment. Total return may be less than anticipated if future interest rate expectations are not met.

Investing involves risk including loss of principal.

©2017 Charles Schwab & Co., Inc. (“Schwab”). All rights reserved. Member SIPC (0317-WNZM).

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