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Money Management: Are interest rates going up in 2015?

On a bi-annual basis, the Philadelphia Federal Reserve conducts a survey of economists’ expectations for various financial metrics, called the Livingston Survey. The Livingston Survey represents a broad cross section of economists from the government, banking, industry and academic institutions.

George W. Karpus

George W. Karpus

Last year at this time, economists in the survey concluded that the yield on the 10-year U.S. Treasury would reach 3.25 percent at the end of 2014 and 3.88 percent at the end of 2015. Even though the yield on even longer-dated bonds was not covered in the survey, many expected a similar increase, which would not have fared well for bond investors.

Not only did rates not rise in 2014, they went down significantly. At the end of last year the yield on the 30-year U.S. Treasury was 3.91 percent and has recently dropped to 2.70 percent. This has caused the 30-year’s price to rise by over 26 percent. After income is added in, an investor would have experienced about a 30 percent total return.

While the story is similar for the 10-year U.S. Treasury, the returns aren’t quite as dramatic. However, because the 10-year yield fell from 3.03 percent to 2.07 percent currently, the total return for the 10-year U.S. Treasury is in excess of 12 percent so far this year. If an investor acted on the general consensus and eliminated long-term bonds from their portfolio, they would have eliminated one of this year’s best performing assets.

At the end of 2013, we concluded that the consensus view was not accurate, which led us to overweight long-term bonds in our portfolios. As a result, our clients have experienced outstanding returns. In looking ahead to 2015, most investment professionals are again predicting a rise in interest rates. After all, rates are so low, they feel they can’t go much lower.

Our work, while not as compelling as last year at this time, indicates that rates can move lower. Actually, as can be seen in the following table, the yield on the U.S. 10-year Treasury is quite high compared to many other countries.

Yields on Select Countries’10-year Government Debt
Switzerland 0.25%
Japan 0.35%
Germany 0.59%
Netherlands 0.73%
France 0.87%
Sweden 0.91%
Canada 1.75%
United Kingdom 1.77%
Spain 1.79%
Italy 2.01%
United States 2.07%

 

Should the United States’ interest rates move toward the middle of the range of the above countries, we believe bond investors could experience another outstanding year of double-digit total returns.

Keeping in mind that investors look to invest where safe, high yields can be found, investors in the countries listed above will be attracted to the high relative rates found in the U.S. causing our rates to move downward and our currency to appreciate. Thus, we feel long-term U.S. bonds (taxable and tax exempt) warrant a favorable allocation in an investor’s portfolio.

George W. Karpus is chief investment strategist and chairman of the board of Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.