What Investors Need To Know About Rising Rates [ProShares UltraShort Lehman 20+ Yr(ETF), iShares Barclays 20+ Yr Treas.Bond (ETF)]

need to knowWhen new Federal Reserve Chair Janet Yellen communicated the Fed’s view on markets after the March FOMC meeting, she left some investors feeling a bit uneasy. Now that the dust has settled, I wanted to reiterate that while the Fed is maintaining its original plan to continue to reduce its bond buying program, when and how the Fed might start raising the Fed Funds rate remains unclear. In particular, the Fed communicated new information on both the timing and drivers of an interest rate movement that bear closer scrutiny.

The Timeline Shift

Until Yellen’s press conference comments, the Fed had not given any specifics on when it would implement a short term interest rate hike, stating instead that it would hold short term rates low for a “considerable time” after it ended quantitative easing (QE)purchases. During the press conference Yellen provided guidance that “considerable time” was about 6 months. This gave the market a much more firm date for rate hikes, and on the news bonds immediately began to price in this new information. As illustrated in the chart below, the market’s expectations for short term interest rates (in this case 3 month T-bill rates), shifted up following Yellen’s comments.

New Economic Indicators to Watch

In previous meetings the Fed had indicated that they were focused on the US economy attaining full employment, and that an unemployment rate of 6.5% was being used as an employment goal. Unemployment is now 6.7% and there was some question about what the Fed would do if they hit their employment goal, but we’re not yet seeing broad economic growth they were hoping for. To address this, the Fed indicated it would focus on a range of statistics including labor market measures, inflation, and other financial developments. This will give the Fed more flexibility in assessing the overall health of the economy and taking appropriate action.

In anticipation of rising rates, investors have piled into floating rate debt and short duration funds in the past year and a half. As Fed policy shifts, it is prudent for investors to adapt their approach as well. Going forward investors should keep three things in mind:

1.    Beware the middle of the yield curve. As my colleague Russ Koesterich notes in a recent Blog post, we are practicing caution within the short to middle part of the Treasury curve and are underweight Treasury bonds with three- to seven-year maturities. This is where the market is re-pricing new Fed expectations and we expect volatility here in coming months.

Pages: 1 2

Leave a Reply

Your email address will not be published. Required fields are marked *