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It is my expectation that in 2017 the stars finally align and we see a rising interest rate environment that we have been anticipating for over 5 years. It is my expectation that the combination of economics, Fed monetary policy, the new administration’s fiscal policy will lead to create that scenario.
Longer duration bonds are more sensitive to interest-rate changes, and have performed worse in rising rate environments historically. Additionally government bonds tend to be more sensitive to rising interest-rates and have historically underperformed corporate bonds during rising rate environments.
Underweights for 2017 (Fixed Income)
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Long-term to Intermediate Bonds: As interest-rates rise, bond prices fall. This is most true for longer duration bonds.
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Treasuries: Government bonds have the lowest degree of credit risk, and the highest sensitivity to interest-rate risk. If the US and global economies continue the expansion in 2017 and the Fed raises rates as expected, government bond prices will likely be hit the hardest.
Overweights for 2017 (Fixed Income)
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Short-term Corporate Bonds: The low duration reduces price risk associated with interest rates. Also, corporate bonds have higher yield spread vs. government bonds which provides more income to offset losses from declines in bond prices associated with rising interests rates.
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High-yield Bonds: Historically high-yield has outperformed relatively in rising rate environments. Improving fundamentals and rising rates leads to lower defaults. On a basic level, high-yield has less interest rate risk and higher credit risk. Meaning that high-yield is more likely to default, and default risk naturally decreases in rising rate environments.
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Floating Rate: Bank loans do well in environments where corporate credit improves. Bank loans typically adjust coupons every 90 days which makes them very defensive to rising interest-rates.
– Wyatt Swartz
Written 1/17/2017
