The US Federal Reserve has started to raise interest rates to combat inflation. The expectation is that they will continue to raise interest rates throughout the year and that these increases may be significant.
Investors are concerned that these interest rate increases will hurt traditional bonds. However, the worst of the damage may already be behind us.
When I use the term traditional bonds, I am referring to the highest quality bonds maturing in the next 2-5 years. This includes US treasuries, FDIC insured CDs, and only the highest-grade municipal and corporate bonds.
To borrow a theme from Charles Dickens’ “A Christmas Carol,” the Federal Reserve represents the Ghost of Christmas Present and traditional bonds represent the Ghost of Christmas Future.
Traditional bonds started to lose value well before the Federal Reserve’s first interest rate increase and they could rally well before the final interest rate increase.
If traditional bonds have guessed the intentions of the Federal Reserve right, they could be a decent investment right now. Their rates of interest are at their highest levels since 2019 and then 2008 before that. If we truly want to believe that the Ghost of Christmas Future knows what it is talking about, then we should do what Ebenezer Scrooge chose to do. Listen to the Ghost of Christmas Future and slowly start investing in these bonds today.
As an example, some FDIC insured CDs maturing in 2-5 years now yield close to 3%, substantially more than that of a money market. Money market yields are still close to zero.
The interest rates of these CDs will not be tracking what the Federal Reserve does at its next meeting or even the meeting after that. They are our Ghost of Christmas Future, reflecting what they think interest rates will be at least a year or two down the road.