Anyone who’s looking for a loan — from a home loan, to a personal loan, to a car loan, to a credit-card loan — had better prepare themselves to pay higher interest rates.
With the Fed embarked on a major campaign to raise the federal funds rate, other interest rates are following suit.
The Fed has raised the federal-funds target by 0.75 percentage point so far, starting in March, and most interest-rate futures traders see another 1.5 to 1.75 percentage points coming this year.
On May 9, the 10-year Treasury yield hit 3.2%, its highest since November 2018.
Meanwhile, the 30-year fixed-rate mortgage averaged 5.27% in the week ended May 5, a 12-year high, according to Freddie Mac. The rate increased from 5.1% a week earlier and 2.96% a year earlier.
“Mortgages now compared to just a few months ago are costing more money for home buyers,” Lawrence Yun, chief economist of the National Association of Realtors, said in a recent speech.
Given our raging inflation (consumer prices soared 8.5% in the 12 months through March) and the likely Fed rate increases, bond yields are probably headed still higher.
In a recent JPMorgan survey of the investment firm’s most active clients who invest/trade in Treasurys and other interest-rate vehicles, 44% were short Treasurys and other interest-rate exposure, twice the amount who were long. A total of 34% were neutral.
A short sale on bonds is a bet that the securities’ prices will drop and the yields will rise.
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Don’t Give Up on Bonds
With this scenario in mind, how should a bond investor react? Now’s not the time to give up on bonds, says Aaron Brown, former head of financial market research at AQR Capital Management.
“There’s a reason to think that bonds will more than make up for recent drawdowns,” he wrote on Bloomberg. Bonds lose when interest rates rise more than expected. If that continues forever, bonds can lose value down to zero.”
But Brown doesn’t see that happening. “In the U.S., interest rates have always reverted to lower levels,” he said.
“When that happens, bond investors are holding high-coupon bonds in a low-interest-rate environment, meaning they have large capital gains. The bigger the bond losses on the downswing, the higher interest rates are, so the bigger the profits on the upswing.”
Treasuries and CDs
You may want to shy away from bond funds, as their values will fall if yields rise. Instead, you can opt for individual bonds.
Conservative investors can buy Treasurys, as they’re almost guaranteed to get the bonds’ par value back when the bonds mature.
And Treasury yields are starting to look attractive. You can do your buying in phases, so that if yields do keep rising, you’re able to take advantage.
You also might consider Series I Treasury Savings Bonds. These bonds have yields that move with inflation, and the payout totals 9.62% through October.
Certificates of deposit are almost as safe as Treasurys, and some of them have yields higher than Treasurys now. You can get a three-year CD yielding 3.1%, compared with the three-year Treasury yield of 2.85%