Take a look at the following chart, which shows the trends for inflation, 10-year treasury yields and the federal funds rate over the last 5 decades.
Looking at this chart brings one and only one question to my mind: where do we go from here?
Before answering that question, let’s consider the context.
Most individuals have 20 to 30 years to make and save their retirement nest egg. Needless to say, the performance of the securities markets (stocks and bonds) during that time and how you manage around that both have a tremendous impact on your financial success during your golden years.
Another factor which is a predictor of financial success during retirement is the current interest rates available to investors as they transition from their accumulation years to the distribution phase of retirement.
At the chart shows, interest rates are at historic lows. Consider the yield on a 10 year US treasury note, currently around 1.8%. On $2,000,000, you’ll earn just $36,000 a year.
Now back to the original question. Where do we go from here?
There are only three possibilities.
- Rates go even lower. Before you dismiss that as a possibility, take into account that there are now many sovereign bond issues around the world paying negative interest, i.e. investors are paying to get most but not all of their money back when their investment matures. With central bankers continuing to maintain such an accommodative stance, this situation could happen. The reality is, however, that compared to the last thirty years rates can NOT go much lower on a relative basis.
- Rates stay right where they are. The argument here is that government debt levels are so high and central bank balance sheets are so bloated that substantially higher rates would be too detrimental to those who control the levers on interest rates. They won’t let that happen because they can’t afford for that to happen…. for years. The mantra for the group on Wall Street espousing this view is “lower for longer.” They have a solid case. But what if they are wrong.
- The last possibility is that interest rates head back north, as in, go up. After years of “printing money,” economic theory suggest that inflation and higher rates are imminent. Well, maybe not, as some have been saying this since 2010 and they have been WRONG. I believe we will see higher rates, and trust me, most professionals will not adequately predict the timing of that rise in rates. Not even me.
So what is an investor in fixed income to do?
- Pay attention.
- Keep maturities shorter as you are not rewarded enough to extend maturities.
- Have a plan for what you intend to do when the technical analysis points to a shift in sentiment.