by Connor Darrell, Head of Investments
Stocks and bonds both fell last week as interest rates moved markedly higher. The yield on the 10-Year Treasury note jumped to its highest level since 2011, and now sits at 3.23%. Interestingly, it seemed that the market movements were sparked by a “good news is bad news” type scenario, where Fed Chair Jerome Powell’s comments that the economy is “firing on all cylinders” prompted concerns of an acceleration in the tightening of monetary policy.
Rising Rates are Nothing to Fear
The activity in markets last week was a microcosm of what many market strategists have feared a rising interest rate environment might create; a period of pressure on both stocks and bonds, where both asset classes struggle to generate positive returns and leave investors with nowhere to “hide”. While it is true that rising interest rates may represent headwinds in both stock and bond markets, we believe there is an emerging opportunity to utilize short-term instruments in a way that has not been available to investors in a very long time. If rate increases continue on the schedule that seems to have been hinted at by the Federal Reserve (which has thus far been very effective at telegraphing its future policy changes), the yields available to short-term fixed income investors could be safely north of 3.5% by the end of next year. At these levels, short-term fixed income can provide stability in a portfolio while still preserving an investor’s spending power.
Bond investors should be further comforted by the fact that the yield curve has begun to steepen again. Historically, an inversion of the yield curve (which occurs when short-term rates move higher than long-term rates) has been a bearish signal for the economy and for markets. However, the yield movements we have observed recently suggest that the probability of yield curve inversion has declined. Investors have not had to grapple with a rising rate environment for quite some time and volatility should be expected moving forward as a result. But there are still reasons to remain optimistic about the forward outlook, and there are tools investors can utilize to help insulate their portfolios from any bumps along the way.