The Federal Open Market Committee has been talking about raising short term interest rates (i.e., Fed. Funds Rates) for more than a year.
After the financial crisis of 2008, the Fed lowered Fed Funds rates to next to nothing (0 to ¼ of 1 percent) in order to stimulate the economy, (Dec. 16, 2008).
Now that the economy is stable and unemployment (the way the government measures it) is low, the Fed is considering raising target Fed Funds rates by ¼ of 1 percent this September.
Investors anticipating this action have been afraid of the bond markets. If interest rates rise, bond prices decline to adjust for the higher rates that become available.
However, higher interest rates are a long-term investor’s friend. It translates into higher longer term returns.
Additionally as you can see from the table below, longer term interest rates tend to rise in anticipation of the Fed raising short term interest rates. Once the Fed begins raising interest rates, the longer end of the bond market performs well.
Federal Open Market Committee
Raising Rates and Returns
Interest rates declined throughout 2014 and bottomed at 2.22 percent as measured by the 30-year U.S. Treasury at the end of January 2015.
Since then, interest rates have risen to 2.85 percent ahead of the anticipated ¼ of 1 percent rise that should occur in Fed fund next month. This is normal.
Once a well-anticipated rate increase occurs, the bond market becomes attractive and produces solid returns in the two years after the initial increase in Fed funds.
Additionally, based on the wide discounts in closed-end bond funds, this is a good time to commit to the bond markets, especially municipals.
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.