What These Charts Show
Since December 2015, the U.S. Federal Reserve has hiked
interest rates six times and at least two more hikes are expected
this year. Given increases in interest rates across the yield curve,
investors have become increasingly concerned about how far
rates could rise. However, a few factors may help mitigate these
concerns. First, much of the expected increase in rates may
be behind us. As the first chart shows, yields tend to track just
below nominal growth. Relatively low growth suggests that
interest rates may be near the top end of their expected range.
A second point, and one that perhaps challenges popular belief,
is that bond investors may actually be better off if rates rise
than if they fall. While bond prices typically fall when interest
rates rise, the yield for those investments rises. So, earning the
yield and reinvesting into higher yields over time can actually
increase the return potential for traditional fixed income.
The second chart demonstrates how forward returns for core
bonds are actually higher when starting yields are higher.
Given today’s higher yields (yellow bar), investors are likely to
experience more attractive returns going forward.