Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
We have been warning about a general shift in interest rates for weeks. In particular, we have focused on the Fed’s directional policy change, which did flip on September 18 when they cut the Fed Funds rate by 50 basis points. The economy has many moving parts that impact the market, which is why the markets have struggled to identify which data points and central bank moves to pay the most attention to. There are over $6 trillion dollars parked in money markets, and if your dollars are part of that pot, it is important that you follow the changing market trend to continue to optimize the return on those funds.
Before the Fed’s first interest rate cut, money poured into money market funds and short Treasury Bills largely because of the high interest rate attached to these short funds. However, do not confuse staying short with staying conservative with your investment strategy. It is an often-taken stance that I argue against. Staying short is not a conservative stance but an interest rate call. An astute investor should remain short as long as they feel interest rates will continue to rise. It is advantageous to keep rolling your investments into higher interest rates as they continue to rise.
However, this strategy begins to backfire when interest rates fall as investors are forced to reinvest maturing dollars into lower interest rates. Locking into higher rates for longer can benefit investors as the market enters a falling rate environment.
Our current interest rate environment may be providing yet another advantage to investors. Investors have capitalized on the inverted curve and elevated short-term rates. The current active Treasury curve (bright green line) shows that short-term rates have decreased after the Fed’s September rate cut. Compare the light gold line, which represents the active Treasury curve immediately prior to the cut, to the bright green current Treasury curve.
What might be more interesting is that the intermediate and long parts of the Treasury curve have elevated over the same period. The Fed has the greatest impact on short-term interest rates, while longer-term interest rates are driven by many other economic factors. This phenomenon provides another opportunity for investors to lock into elevated income levels for longer. Many investors have short-term liquidity needs and will remain in money market instruments regardless of interest rate levels. However, investors using money market instruments to augment their income can lock that in for longer by shifting funds from money markets into the intermediate and/or long end of the curve.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.
