Interest rates have been on the rise, and for good reasons. The Fed has been slowly raising short-term rates for more than two years as it seeks to return interest rates closer to normal levels and stimulus provided by low rates is no longer needed. Long-term interest rates have also increased due to higher economic growth, modestly higher inflation and expectations of further Fed rate hikes. Our view is that as long as inflation remains near or above 2%, the Fed can continue to slowly hike short-term rates without cutting off solid economic growth.
Because bond prices generally move in the opposite direction from interest rates, rising rates have lowered prices of bonds in portfolios, affecting short-, intermediate- and long-term bonds, bond funds and ETFs, as well as unit investment trusts (UITs) that hold bonds. Additionally, the sensitivity of bond prices to interest rates depends on maturity, with short-term bonds less impacted than long-term bonds. In this case lower bond prices are primarily the result of higher rates, so we don't see cause for concern. And remember that interest paid on bonds is based on par value - not market value - so income should not be affected. In fact, income should increase over time as bonds mature and the cash is reinvested at higher market rates.
Rising rates could impact bond returns, particularly longer maturities. That said, we continue to expect interest rate increases to be gradual over time, and bonds still play a role by providing diversification and income. Long-term bonds also have a place in fixed-income portfolios by paying higher rates and steadier income over time. When rates are rising and the economy is strong, stocks have performed well. But rising rates may increase volatility.
Bonds can provide diversification, income and stability, which continue to make them an important part of a well-diversified portfolio. You can’t predict interest rates, but you can prepare your portfolio. Consider the following:
Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.