RANDY FREDERICK: Last month the Fed hiked rates for the third time since the financial crisis. Collin Martin, a fixed income strategist at the Schwab Center for Financial Research, joins me for the April 18th Schwab Market Snapshot, to discuss why long-term rates have drifted lower, back down to about where they were before the very first rate hike. Welcome back, Collin.
COLLIN: Hi, Randy, thanks for having me back.
RANDY: So, Collin, we have had three one-quarter-point rate hikes in the past 15 months, and two of those happened in just the past four months. Yet, interest rates on long-term bonds have been falling off recently. What is driving these lower yields?
COLLIN: We really see two drivers right now. We think it’s a mix of geopolitical concerns, but also a fading of the post-election optimism that had sent yields higher in the first place. Now remember, after the election long-term bond yields moved sharply higher as investors expected more expansive fiscal policies that would hopefully boost growth and inflation. That began to fade a little bit after the healthcare bill failed to pass, which likely pushed back the timetable for other measures to be passed by Congress.
And then recently we’re seeing yields move even lower due to geopolitical concerns. U.S. Treasuries are considered one of the safer investments out there, so with U.S. military intervention overseas, that’s caused demand for treasuries to go up, pushing their yields lower. So that’s really why we’re seeing long-term yields fall, even though the Fed’s been hiking rates.
Now at 2.2% right now, 10-year treasury yields are at the lowest level this year, and they’re actually back to where they were right before the Fed hike for the first time in December 2015.
RANDY: So it sounds like optimism about “Trumponomics” is beginning to wear off. So has this changed your outlook for interest rates going forward, and if so, how will that affect investors?
COLLIN: Well, we do think the geopolitical risks could push yields a little bit lower in the near-term, and then what we really need to see to get yields higher is an improvement in the economic data. Since the election we’ve seen surveys and confidence reports really move higher, but we haven’t seen actual hard data follow that trajectory. Now remember, long-term bond yields are driven more by growth and inflation and less by Fed policy.
So in the first quarter economic growth is expected to be pretty low, and inflation is actually starting to show some signs of slowing. It’s been rising over the past year or so, but much of the recent rise has been driven by oil prices. Now with oil prices today pretty close to where they were a year ago, you know, that impact might start to fade a little bit. It looks like the market needs to see more proof that all prices are rising, not just oil prices.
And it looks like the market’s—so the market’s kind of in wait-and-see mode—to see this economic data, to really get yields to move higher from here. Now that being said, we don’t think investors need to be in wait-and-see mode. If you’re waiting for yields to move higher, a lot of yields already have. Even though we’re talking about long-term yields falling, short- and intermediate-term bond yields have risen since the Fed’s hike three times since the end of 2015.
So we don’t think it makes sense to try to time the market or try to wait for the peak in interest rates. We think it makes sense to invest for income today. If you are concerned about the risk to rising yields to your bond holdings, we think it makes sense to just shorten the duration of your portfolio a little bit—maybe reduce the average maturity of your holdings a little bit. Short- and intermediate-term bonds can still provide income, they can still provide diversification benefits to your overall portfolio, and their prices tend to be less sensitive to interest-rate rises than those of long-term bonds.
RANDY: Well, that’s about all the time we have for today, Collin. That sounds like great information. Listen, if you want to read more about Collin, you can do that in the fixed income section of Schwab.com. And don’t forget, you can follow me on Twitter @RandyAFrederick.
We’ll be back again. Until then, invest wisely; own your tomorrow.