April 6, 2023 Everyone has an opinion on what the Federal Reserve should do with interest rates during their next meeting in May. Analysts and economists are dissecting every word said by Fed officials trying to get a head start and advantage before any announcement is made after that meeting.
What the Fed is Saying
Depending on which economist or analyst is speaking in the financial media, their opinions range from rates will increase, rates will decrease, or rates will remain the same. It is important to remember that the analysts and commentators in the media are not the ones actually making the policy decisions. The Federal Reserve sets the interest rates and the monetary policy in the US. Federal Reserve officials have remained consistent about their messaging to bring inflation back to the 2% level. Raising interest rates is one of the major tools the Fed can use to slow the economy and in turn reduce the rate of inflation. After the Federal Reserve meeting last month in March, Fed Chair Jerome Powell said, “If we need to raise rates higher, we will.” The Fed has announced that they are predicting rates will rise in May and then leave them steady for the remainder of the year. As new economic data is released, this prediction may change.
What does this mean for our portfolios?
As interest rates rise, the value of an already-issued bond will decrease. When the interest rate declines, the value of that bond will increase. Last year we saw interest rates rising much quicker than anyone expected and long-term bonds and long-term bond funds were especially hard hit. We had positioned our clients in short-term bonds and short-term bond funds where the decrease in value was much less and it also provided a much-needed balance to the stock market volatility and declines we saw last year. Now, as the cycle of rising interest rates appears much closer to the end, we are looking for a balance of stability and yield for our client portfolios. There is still volatility in the bond market due to the uncertainty of where interest rates will be later this year and next year and there is still stock market volatility due to the ongoing concerns about the economy and the effect higher interest rates will have. This balance of stability and yield is different for each of our clients based on their financial goals and the timing of those goals.
Conclusion
The rising interest rates have had an impact on the US economy and hence caused volatile market returns. This is normal as the markets do not like uncertainty. This said, if history remains our guide, at some point interest rates will stop rising and just as the stock market has always done, it will return to more normalized rates. For now, everything remains dependent on economic data that has not been released yet. And we can and will adjust accordingly. All of this points to just how difficult it is to predict the future, not just with interest rates but also with the financial markets and global economic conditions. Hence we never sway from our discipline of using “history as a guide” and never rely on guesswork. For us here at Prato Capital, maintaining a proper balance of risk and stability in our client’s globally-diversified portfolio is key to everyone’s financial success. We remain as confident today as we did in the past that keeping a long-term outlook offers the best possible way to achieve one’s financial goals. For those interested in reading further on interest rates and bonds, please see the links below.
Why Go Long When Short-Term Bonds Yield More? – Charles Schwab
Bonds Are Back to Work in Asset Allocation – Lord Abbett
Gregory, Gabriella, Brian, Samer, and Chris
Prato Capital Management Where Integrity Meets Discipline
“More money has been lost reaching for yield than at the point of a gun.” – Raymond DeVoe, Jr. – Financial Writer
