Rising interest rates and the bond market: What is the risk?

As many investors have started to note, interest rates have begun to rise. The Federal Reserve has signaled at least three interest rate hikes for the calendar year 2018. As the additional concerns of rising inflation begins to mount in the eyes of many forecasters, it is entirely possible that the Fed will act even more aggressively in raising their target rate.

Differing economic conditions can pose challenges to various different asset classes, as well as investment vehicles within a given asset class. A rising interest rate environment is generally perceived to be a poor environment for fixed-income investments. This tends to be true in a broad sense, although not exclusively true in all areas of fixed-income. Certain types of fixed-income investments tend to do well in a rising interest rate environment. One such example would be High-Yield bonds, which tend to benefit from expanding credit.

In a more broad sense, rising interest rates are a challenge for bonds. The simple reason is that existing bonds are priced based on a number of metrics such as credit quality, maturity, callable features and the coupon of the bond. The coupon is the stated interest rate the bond pays when it was issued. If you purchased a bond paying 3%, and new bond offerings of a similar profile are offering 5%, this makes the bond you hold less attractive and will devalue that bond in the eyes of the current marketplace should you wish to sell it prior to maturity. Even if you have no intent on selling a bond prior to maturity you may suffer from some “statement shock” when you notice the reduction in value.

Joe Favorito

Joe Favorito

Joseph Favorito is a Certified Financial Planner™ who began his career in the financial services field in 1997. Over the past two decades Joseph has worked for several New York stock exchange members. In 2011 he founded Landmark Wealth Management, LLC , a Long Island-based Securities Exchange Commission registered investment advisory firm.

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