We Might Be Here For A While
Drew O'Neil discusses fixed income market conditions and offers insight for bond investors.
Last summer, the lower bound of the Fed Funds rate was at 2.25%. Six months after that, the Fed had lowered it down to 1.50%, and by March it had fallen to 0.00%. The slow and methodical three year climb of the Fed Funds Rate from 0.00% that started in December of 2015 was undone in a matter of months, just as we were getting used to relatively decent returns on money markets and other short-term investment options. Now here we are back at 0.00% on the Fed funds and money market yields south of 0.15%. Just because the world was a very different place just 6 months ago (in terms of both pandemics and interest rates), doesn’t mean that interest rates will return to their pre-pandemic levels any time soon. There is a good chance that 0.00% Fed Funds will be around much longer than the pandemic.
The graph to the right charts both the Fed Funds rate and money market yields over the past ~12 years. As you can see, as the Fed Funds go, money market yields follow. While we all enjoyed our 2019 money market yields, when thinking about portfolio construction and when and how to invest, it is important not to forget the recent history. Following the great recession, Fed Funds was lowered to zero, where it remained for 7 years. As the graph shows, money markets earned very little for that entire timeframe. Based on recent comments from the FOMC, it is not looking like this round of ZIRP (Zero Interest Rate Policy) is going to be short-lived either. The future is unknown, but it is not outside the realm of possibilities that we could see a similar situation for a prolonged period, perhaps comparable to the most recent 7-year ZIRP. Rather than wish yields were higher, a more constructive line of thinking may be to look for the best values in the current market that align with your goals.
With yields across the board lower than most investors would likely prefer, it is easy to get discouraged and as a result, do nothing. But doing nothing is a decision and it can be costly. Earning 1.00% on a 5-year corporate bond might not get many investors too excited, but when the alternative is to do nothing and earn 10-15 basis points in a money market, 1.00% doesn’t sound that bad. It is all about perspective and framing. 1.00% might not sound very rewarding, but when framed as earning 6 to 7 times what you would make in a money market, it sounds a whole lot better. Combine that attractive relative value with staying within your risk tolerance and in line with your objectives, and buying a 5-year bond earning 1.00% might just be the best decision you can make given the current investing landscape.
Whether we want to admit it or not, we are likely entering a new phase of lower interest rates, for potentially a longer amount of time than many of us would wish for. The graph above shows the effect that the Fed can have on interest rates for a long period of time. As the world central banks deal with the current pandemic and the hopeful recovery over the next several years, they are likely to be focused on keeping interest rates low across the board to aid in the recovery. Long-story, short… we might be here for a while. Sitting in cash or ultrashort-term funds has its purpose (generally liquidity and safety), but it is likely not helping you achieve your long-term financial goals. Take a step back, look at the options that are being presented to you by the market, and find best value that you can that also aligns with your long-term goals.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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