Ask the Rational Investor: Reposition your bond portfolio

A year ago, a one-year United States Treasury bond yielded about 1% and 10-year bonds yielded close to 2%. Since then, the Federal Reserve has increased interest rates swiftly and the interest rates have increased to 4.7% and 3.5%, respectively.

It is unusual for short-term bonds to yield less than long-term bonds, but occasionally this occurs when the markets believe that the economy will fall into a recession and the Fed will reduce interest rates to stimulate the economy. Currently market participants are anticipating a recession may occur and are purchasing the longer-dated bonds bidding up the price and lowering the yield.

Over the last twelve months fixed-income markets have changed dramatically and investors should consider repositioning their bond portfolio. An example might be that years ago you purchased long-dated bonds stretching for yield and now have losses? Realizing these losses and purchasing higher-yielding short to intermediate bonds could add considerable income.

Some investors may purchase municipal bonds that offer lower interest rates but are tax-free at the federal and possibly state level. Investors should calculate their own taxable equivalent yield based on the marginal tax rate they are paying. In general, these bonds are currently more expensive to treasuries than normal. The exact reason is unknown, but we think it has to do with the Federal Reserve shrinking their balance sheet and an expectation that tax rates may rise.

The Federal Reserve has pledged to reduce inflation to their long-term goal of 2%, which may require additional increases in the Fed Funds rate. Because interest rates could continue to climb 0.50-1% over the next 12 months, investors should consider purchasing short-term bonds which will allow them to reinvest matured months at higher rates and then consider if extending the average maturity of the portfolio makes sense.

Each portfolio has different goals and risk tolerances and investors should consult with their portfolio manager prior to making any changes to discuss their specific situation.

Sources: Factset

Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms.  The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.