Rising Rates Causing Portfolio Volatility
Interest rates remain low by historical standards but they're finally moving up a bit. The 10
-year treasury was yielding around 1.2% as recently as August, and now is over 1.8%. (Doesn't seem like much but that's a 50% increase in less than 6 months). 30-year mortgage rates were at roughly 2.8% in August and are now closer to 3.5%.
So why are rates moving higher? Many things influence the movement of interest rates but it’s fairly obvious the Federal Reserve is a big reason rates are moving higher now. At year’s end, U.S. inflation reached 6.8%, the fastest annual rate since 1982. Barely anyone working today has any practical memory of inflation as a serious problem or threat. Inflation had remained calm for almost four decades, ever since the Federal Reserve aggressively raised interest rates in the early 1980s to combat inflation then. The Fed believes that it now must try to combat inflation again. There are two primary ways the Fed will attempt to do this.
1) Reducing the money supply. Reducing the supply of dollars, makes each remaining dollar more valuable. As the value of each dollar increases, so does its purchasing power. This slows down inflation. The Fed started reducing the money supply by slowing their purchase of mortgage bonds in December and are expected to end all purchases by March.
2) Raising interest rates. Inflation is caused by too many people trying to purchase too few goods and services. Raising rates slows the pace of consumption and investment in the economy and therefore can slow inflation. The Fed is now expected to hike rates 4 times this year, with a year-end Fed Funds Rate target of 1.0 – 1.25%. The current Fed Funds target rate is 0 – 0.25%. How does this impact your investments?
We’ve discussed the inverse relationship between interest rates and bond prices in the past. As interest rates rise, bond prices usually fall, and vice-versa. I think most investors u