CIO Insights: Reassurance About Fed Policy and Interest Rate Changes


G. David MacEwen Chief Investment Officer, Fixed Income

G. David MacEwen Chief Investment Officer, Fixed Income

Based on fundamental economic and market analysis, our Fixed Income Macro Strategy Team still believes U.S. interest rates will remain relatively low and range-bound in coming months. Despite the tapering talk, we believe that the present environment still does not support a big change in Federal Reserve (Fed) monetary policy or a massive rise in U.S. interest rates. We think the Fed will likely stay largely on its present course with its bond purchases and interest rate targets, even if it tapers the bond purchases somewhat.

Read MacEwen’s full Q3 2013 CIO Insight:
Reasons Not to Fear Fed Uncertainty and Rate Changes

“Higher interest rates can provide benefits for bond investors over the long run.”

The team believes rates will eventually elevate out of recent ranges. But rising rates won’t be entirely bad for bonds over the long run. Higher yields can signal economic improvements and can also provide important long-term income benefits for patient bond holders. Our research indicates that income historically has been the primary component of fixed income returns over time, not price changes. Higher levels of interest income also help reduce overall return volatility. So while rising rates will have a negative near-term impact on bond values, we believe the value declines can be mitigated over time as bonds mature at par and are reinvested at higher yields.

Summary

  • We believe that the present environment still does not fundamentally support a big change in Fed monetary policy or a massive rise in U.S. interest rates in the near term.
  • We think an economic recovery has taken hold, but it’s been very slow and subpar, particularly in the U.S. labor market. High unemployment and underemployment remain significant headwinds to economic expansion.
  • We fully recognize that higher rates will eventually come. But rate increases are not necessarily going to be catastrophic for bond investors. In fact, higher interest rates can provide benefits for bond investors over the long run.
  • Recent historically low interest rates slapped a form of financial repression on savers, retirees, and other income-oriented investors. Over time, higher yields are, in fact, desirable in fixed income markets.
  • We believe investors can prepare for higher interest rates by keeping their bond portfolio durations relatively short, choosing their sectors wisely, and holding their investments for at least the length of their portfolio durations so the bonds have time to mature and be reinvested at higher yields.

Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.

Diversification does not assure a profit nor does it protect against loss of principal.

The opinions expressed are those of G. David MacEwen and are no guarantee of the future performance of any American Century Investments portfolio.

For educational use only. This information is not intended to serve as investment advice.

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