Re-positioning of Bond Portfolios Given Changes in Interest Rates and Economic Outlook

Short Maturity Bond Positioning Has Outperformed in Recent Years.

Since mid-2020, when the 10-year Treasury yield bottomed at less than 0.50%, short-term bonds have outperformed intermediate and longer-term bonds as interest rates rose to more normalized levels. That’s because of the inverse relationship between bond yields and prices. Bond prices decline when interest rates rise, and when bond prices fall, long-term bond prices decline more than short-term bond prices.

Higher Rates Present an Opportunity to Extend Bond Maturities.

High-quality bonds are offering the highest yield levels in over 15 years following a nearly four-year rise in interest rates. With the 10-year Treasury yield above 4% and many core and high-quality corporate bond funds and ETFs yielding more than 5%, forward-looking returns in fixed-income have become more attractive, in our opinion.

Additionally, the inverse relationship between bond yields and prices can, at times, work in our favor. Bond prices rise when interest rates fall. And when bond prices rise, long-term bond prices rise more than short-term bond prices. Should the Federal Reserve eventually lower interest rates in the coming months or years, we expect intermediate-to-long-term bonds to benefit to a greater degree than short-term bonds.

Question & Answer

Q: What is an “inverted yield curve”?
A: The yield curve is normally positively sloped, meaning as the length of bond maturity increases, the yield also increases. However, the yield curve is currently inverted, indicating that short-term Treasury bonds offer a higher yield than long-term Treasury bonds.

Q: Given the inverted yield curve, why own longer-term bonds when shorter-term bonds offer higher yields?
A: Short-term bonds are subject to greater reinvestment risk than long-term bonds. Reinvestment risk refers to the possibility that an investor will have to reinvest bond interest or maturity payments at a lower future interest rate than the original investment. Short-term bonds lock in the yield for a shorter period of time (3 months or 1 year, for example). Long-term bonds lock in the yield for a longer period of time (5 years or 10 years, for example); therefore, if interest rates decline, investors will continue to receive higher yields for a longer period.

Q: Historically, what has been the right investment strategy when the yield curve was inverted?
A: Historically, when the yield curve inverts, extending bond maturities has produced higher future total returns on an average annual basis. Over the last 25 years, the average annual total return for the two years following a yield curve inversion has been 9.2% for the Bloomberg Bond Index (intermediate average maturity) versus 3.4% for rolling 30-day Treasury Bills (short average maturity). While the future direction of interest rates is uncertain, locking in high rates now may/can reduce reinvestment risk for investors and may potentially produce a higher total return should interest rates decline in the coming years.

Q: What impact could potential Federal Reserve interest rate cuts have on bond investments?
A: Historically, when the Federal Reserve (Fed) lowers its benchmark interest rate, other interest rates directionally follow. Short-term bond yields, which are more directly influenced by Fed rate movements, tend to fall by a similar magnitude as the Fed reduces its benchmark rate. Long-term bond yields directionally also declined, but the magnitude can vary since long-term bond yields are also heavily influenced by other factors such as inflation and economic growth.

Recall, there is an inverse relationship between bond yields and bond prices. Therefore, in response to interest rates declining, bond prices are expected to rise. Long-term bonds, which have longer duration and high sensitivity to interest rate changes, rise in price by a larger amount than short-term bonds when interest rates decline.

Sources:

• Sequoia Financial Group, Fidelity, and Charles Schwab.
• Bloomberg, Y Charts and Federal Reserve Bank of St. Lewis.
• Federal Reserve Bank of St. Lewis.

This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Diversification cannot assure profit or guarantee against loss. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses. Sequoia Financial Advisors, LLC makes no representations or warranties with respect to the accuracy, reliability, or utility of information obtained from third-parties. Certain assumptions may have been made by these sources in compiling such information, and changes to assumptions may have material impact on the information presented in these materials. Sequoia Financial Advisors, LLC does not provide tax or legal advice. Investment advisory services offered by Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.