This is the final post in the miniseries The Ultimate Guide to Understanding Bonds. Click the link to start from the first post.
Bond markets have a oracle of sorts that the stock market does not: the Federal Reserve. The Fed controls interest rates – one of the two major drivers of bond prices – and they helpfully publish regular guidance as to what they hope to do.
The Fed just raised interest rates 25 basis points in December 2016. In that meeting, they stated they have said they anticipate 3 more rate increases in 2017. Of course, any future rate increases are predicated on continued strong economic health. There have been times the Fed has signaled an intention to raise interest rates only to back away later because economic indicators gave them pause. Still, I would characterize it as a strong likelihood that we see rising interest rates in 2017 and beyond.
(09/07/2017 Note: Similar to 2016 it appears the Fed will not be raising rates nearly as much as they had intended. There is discussion that their understanding of what drives inflation has been flawed and will lead to holding rates steady for quite a while. This makes buying bonds in the near-term more exciting because this dynamic is less of a concern).
What about perceived security vs other assets? If you’ve read the first part in the miniseries, you’ll know that my view is that stock returns will trail historical returns by about 1-2 pts in the coming decade. While that sort of prediction is more suited to a decade than any individual year, it suggests to me that bonds will look more attractive than they have before (taking the same amount of risk in stocks and making 2 pts less a year is going to make other things look comparatively more attractive). From a long term view, I am excited to increase my allocation in bonds.
Does that mean I think you should pick up some bonds now? Absolutely not, unless you really need a steady cash flow source. If the rate is going to rise up to 75 basis points in less than 1 year, I absolutely do not want to lock in multi-year bonds where I’m paid 75 basis points less than my peers and see a huge depreciation on the face value of the bonds I bought. But in a couple of years, buying a major slug of bonds and living off the interest could be a very real possibility, the way it was in the 1980’s.