Market Insights - March 2018
The Return of Yield and What It Means To Your Portfolio
In the U.S., the Federal Reserve has begun the process of “normalizing yields” In his first interest rate decision, newly appointed Fed chairman Powell affirmed strong economic growth and projected three Fed fund increases in 2018, and markets reacted calmly to what seemed to be a continuation of the gradual and transparent policies of his predecessor. The immediate impact of this policy has been on CD and money markets; rates that were at or near 0% since late 2008 have gradually risen as the Fed embarked on this long and winding road in December 2015 when it raised the Fed Funds target rate from 0% to 0.25 The effect has been pronounced in the Treasury market as yield on the 90-day Treasury Bill has risen to 1.72% from near 0%, the 1-year Treasury Note is up to 2.15% and the 10-Year Note has come close to 3% in recent weeks and is expected to end the year near that level. CD rates are rising as well, and mortgage rates have moved up to 4.25% - 4.50% for a 30-year fixed versus under 4% for most of last year.
Municipal bonds, which are free from Federal tax and in many cases state tax as well, have seen their yield rise as well because of the Fed normalizing. However, there was an additional factor that affected Municipal bonds, the passage of Tax Cuts and Jobs Act in late 2017 (TCJA). The concern was that was that the changes to the tax code would result in materially lower tax rates, making municipal bonds less competitive. This largely did not materialize as the higher-end tax rates for individuals did not drop as much as expected, thus keeping municipals very competitive on an after-tax basis with taxable bonds.
One concern in a rising rate environment is that the price of a bond you currently own declines as interest rates rise. However, in many cases when investors can reinvest the higher yields the effects of rising interest rates on total return can be mitigated.