In Periods of Rising Rates, Higher Income Can Help Keep Returns Positive




As the Fed continues on a path of gradually raising interest rates, many investors are moving to cash, short-term bonds and floating-rate securities. But the view that bonds have to suffer losses when short-term rates rise is a misconception. Looking at the past seven periods of interest rate hikes, including the current period, investment-grade bonds (BBB/Baa and above) have generally delivered positive returns, as can be seen from results for the Bloomberg Barclays U.S. Aggregate Index in the chart above.

If rate hikes are gradual, interest earned by bonds can overcome the price impact to deliver a positive return. Indeed, since the Fed began on its current course of rate hikes, the index has gained nearly 6%, even as the Fed funds target has risen by 100 basis points. The Fed has signaled that it will maintain a gradual pace in raising rates and tightening monetary policy. Against this backdrop, interest rates will likely remain range-bound.

Bond ratings, which typically range from AAA/Aaa (highest) to D (lowest), are assigned by credit rating agencies such as Standard & Poor's, Moody's and/or Fitch, as an indication of an issuer's creditworthiness.

2018 Outlook: Time for Balance and Flexibility

What are the investment implications to consider as you position portfolios for 2018?