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Thursday, December 8, 2016

Financial Focus - Interest Rates Have Risen: What Is the Impact on Bonds?

With the November election behind us, interest rates have risen, driven by expectations of lower tax rates, higher government spending, and less regulation, which have helped lift expectations for faster economic growth and higher inflation.  This, in turn, has raised investors' outlook for short-term interest rate hikes by the Federal Reserve. However, there is some uncertainty regarding what policies and legislation Congress and the new administration will actually pursue.

Bond Prices Have Declined
10-year Treasury yields have rebounded to their highest level since last December, surging above 2.3% from 1.8% during November.  Remember that rising rates mean that bond prices decline, and long-term bond prices have dropped more than short-term bond prices.  This means that you should be prepared for prices for bonds and bond funds to be lower on your November statement, although comparable to levels from earlier in the year.  While this is not a reason for you to sell, setting expectations about bond price performance and properly laddering your bond portfolio can help position your portfolio for interest rate risk.

Where Do Rates Go From Here?
It's too early to declare certainty with regard to recent policy proposals, or to suggest their impact will be as effective in driving higher growth and inflation, as recent stock and bond market reactions might be signaling. Nevertheless, we think the broader path ahead for rates is higher, though not necessarily with the vigor seen since the election. Moderate U.S. GDP growth, helped by a solid labor market, should support a Fed rate hike next month and a measured approach toward additional rate increases in 2017.

Bonds Still Offer Value
Even with the recent jump in rates, bond yields remain fairly low by historical standards. That said, bonds still offer a compelling value in today's environment given the stability they provide portfolios. During the stock market correction this January-February (-12.0%) and during the Brexit pullback (-5.3%), bonds rose an average of 1.8%.1 Owning bonds during these stock market downturns would have helped stabilize portfolios, which demonstrates the diversification benefits that bonds provide.  

The steady ascent of the stock market in the past few weeks will not continue uninterrupted.  While we think fundamental conditions will support equity gains ahead, the current balance of global risks and opportunities will, in our view, prompt episodes of volatility, during which bond allocations should deliver portfolio stability desired by long-term investors.

What Should Investors Do?
Interest rates can't be predicted, but you can prepare your portfolio.  Consider the following:
  • Review Portfolios.  Review the mix of stocks and bonds in your portfolio.  If needed, rebalance to the appropriate amounts.
  • Adjust bond ladder. Review bonds for alignment with our laddering guidance.  Make sure your portfolio isn't overweight in long-term bonds.  Short-term and intermediate-term bonds pay lower rates, but they will be less impacted by rising interest rates.  Plus, when shorter-term bonds mature, the proceeds can be reinvested at higher interest rates.
  • Avoid emotional investing. Even when bond prices decline, they will move closer to face value as the bonds get closer to maturity, assuming no concern about default.  Also, the income that bonds pay won't change if rates go up.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor, which in Prescott is Neal Robinson at 1400 N. Acres Dr. Suite 55

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