FINANCE: Fixed Income Investments Struggle in Fed Limbo

By Patricia Kummer; Kummer Financial Strategies- Highlands Ranch
Posted

Business owners, retirees or anyone looking for higher yields on short-term investments may have just gotten their wish….Or wait, is the drop in the value of my fixed income portfolio worth another half of percent in yield?  Probably not, and it is not likely to be sustainable.

The interest rate on money markets and short-term bonds has been near zero for years.  This is the price you pay for liquidity.  Therefore many investors stretched their risk budget to include higher-yielding instruments such as dividend-paying stock, master limited partnerships (MLPs), or high-yield, lower credit quality bonds.  These may have provided higher returns but watch the net asset value when there is even a hint of the Federal Reserve removing some of the artificial stimulus.

The interesting thing is the Fed never said they were tapering off their bond-buying program.  This was the speculation based on slightly better than expected economic data, including housing.  What Fed Chairman Bernanke actually said was “the fundamentals look a little better to us”.  I believe he is paving the way for an opportunity to gradually take his foot off the gas but this will happen before he puts on the brakes.  The bond market reaction behaved as if he was slamming on the brakes first.

Dr. Jerry Webman, Oppenheimer’s Chief Economist published a great commentary based on the recent Fed meeting.  He said, “If the Fed’s goal in announcing a swifter tapering of asset purchases was to avoid a rally becoming yet another asset bubble, they may have succeeded. The pendulum has now swung from concerns that the Fed will stay loose for too long to fear that the Fed will be too quick to tighten. Such concerns are likely to be very premature. Given the current run rate in nonfarm payrolls, the economy is still nearly two years away from the Fed’s targeted 6.5% unemployment rate. Stable aggregate prices and no effective wage pressure mean that inflation is unlikely to force the Fed to tighten soon. The market’s reaction—higher interest rates, cheaper stocks—has, itself, already tightened financial conditions, providing the Fed with more room to keep policy loose. I believe treasury rates are unlikely to rise significantly from here, and short-term interest rates are likely to remain low for a long time.”

Based on this viewpoint it appears we remain in interest-rate limbo for the time being.  Therefore be careful stretching your risk budget on more types of fixed income, which will likely not give the type of negative correlation needed for a balanced portfolio.

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Patricia Kummer has been an independent Certified Financial Planner for 27 years and is President of Kummer Financial Strategies, Inc., a Registered Investment Advisor in Highlands Ranch, 3 year Top Wealth Manager 5280. She welcomes your questions at www.kummerfinancial.com or call the economic hotline at 303-683-5800.Any material discussed is meant for informational purposes only and not a substitute for individual advice.

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