Interest Rate Changes = Bond Portfolio Changes

April 18, 2018

 

Finally, after 10 years, we're seeing fundamental shifts in the fixed income markets that are going to result in us making significant changes to the bond portfolios of our clients. Let me explain the how and why.

 

Hello, my name is Paul Carroll. I'm the CEO and Founder of Efficient Wealth Management, a boutique wealth management firm. Since the 2008 recession, there's been a significant amount of monetary easing. Ben Bernanke was called “Helicopter Ben” for a good reason. He wrote a thesis that in that kind of an environment, you should drop money on the economy until the recession is over, and he did that, and it worked.

 

But today there's a lot of cash sloshing around the system, and that extreme liquidity needs to be mopped up. That process drove interest rates down to the lowest rates since the 1800s, and finally, they're beginning to creep up. So what's causing interest rates to start to creep up? First, there's an unwinding of the monetary easing. The Fed is actually trying to take that cash out of the system, very gently, to avoid any shocks.

 

In addition, I think the markets are expecting the dollar to continue to drop slowly against other currencies, in no small part due to the trade wars that are beginning at this point in time. That increases interest rates and inflation. There's continued global growth, and the global economies all impact the global market for dollars. And what is interest if it's not the price of money?

 

And finally, the enormous tax cut. This tax cut adds a trillion and a half dollars to the debt. That's demand for money, and whether or not it's a good or bad policy, it will increase the demand for money and it will therefore very likely increase interest rates over time.

 

All of these elements put together are resulting in real changes in what we call the yield curve. All the yield curve is is a picture of the interest rates at different maturities. When the yield curve changes shape, then the duration that we target has to change also, and because of these changes, we're moving our duration even shorter. Duration is, simply put, the time-weighted maturity of the bond portfolio. We're shortening our duration because we can. Because with this shortened duration, finally ultra short-term bonds are paying sufficient interest. That through a combination of exchange-traded funds, and mutual funds, the efficiency of which is somewhat dictated by the size of the trade. That combination is allowing us to get safer without giving up yield, so we're going to do it.

 

What you're going to see is significant trades in your bond portfolios in the coming week. There's certainly nothing to worry about. If anything, this is great. Finally, the yield curve has moved in a way where we can enjoy returns while enhancing safety on that part of your portfolios that should be safe.

 

We wish you the best of investing success, and thank you.

 

Source:

 

Federal Reserve. “Federal Reserve Issues FOMC Statement.” FRB: IFDP Notes: The Effects of Demographic Change on GDP Growth in OECD Economies, Board of Governors of the Federal Reserve System (U.S.), 21 Mar. 2018, www.federalreserve.gov/newsevents/pressreleases/monetary20180321a.htm.

 

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