Our View on Interest Rates
We seldom recommend temporary changes in investment policy – when we do make changes, we expect them to last for the foreseeable future. However, over the next few weeks we will be implementing changes with a relatively short-term outlook for our clients. This change solely involves the maturity of bonds – we will be moving a portion of most client’s portfolios from intermediate bonds (with an average maturity of 5-6 years) to short-term bonds (with an average maturity of 1-3 years).
There are three reasons for this shift:
Most economists, including those who sit on the Federal Reserve Board of Governors, expect short-term interest rates to increase by between 1% and 1.25% over the next 18 months. While increases in rates on short term bonds are not always the same as increases on longer term bonds, we expect some increase in the rates on intermediate-term bonds, which will cause declines in their prices over the next 1 ½ years.
The average maturity of intermediate term bonds has increased over the past year, meaning the potential price decrease is larger than it has been in the past.
The yield difference between intermediate term bonds and short-term bonds has decreased over the past year. For example, in the beginning of 2017, five-year Treasury bonds paid a yield 0.7% higher than that of two-year bonds – currently, that difference in yield is only 0.3%. The two year yield has more than doubled, while the five year yield has only risen by about 50%.
This means the risk of intermediate bonds (relative to shorter term bonds) has increased, while the reward of taking that risk has declined. For that reason, depending on the specifics of your portfolio, we will be making appropriate adjustments (the specifics will be dependent on other aspects of your portfolio and cash flow needs). We do not recommend moving all your portfolio out of intermediate bonds – as always, diversification is an important facet. If you’re a client of Savant, you may see trades in your portfolio if adjustments need to be made. If have additional questions, please don’t hesitate to contact your advisor.
We don’t expect this change to be permanent. After rates have risen, or if there is a shift in Fed policy or other economic factors, we expect to move back into a more intermediate term strategy.
If you have any questions, please contact us at Savant.