Long-term planning versus short-term speculation

by Doug Drabik, Fixed Income, Raymond James

As we near the last couple of months of the year, the loudest noise still echoes the Fedā€™s decision on whether they will hike short-term interest rates or leave them alone. Of course the Fedā€™s self-proclaimed mantra, their transparency, has been about as clear as mud. Based on the latest implied future probabilities, there is now a 67.6% chance that the Fed hikes interest rates in December, bypassing the November FOMC meeting which falls just days before the presidential election. When looking at where we stand, one starts to wonder if the most compelling reason for a hike at this point is just to prove that they can.

Over the last month, interest rates have shifted up but this move is still slight when stepping back and looking at the big picture. Interest rates are still lower than where we started the year.


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Now take a look at where global interest rates are. Although some conjecture is circulating about certain central banks potentially slowing their accommodative positions, the European Central Bank, Bank of Japan and Bank of New England remain actively accommodative. The global trend in interest rates remains downward and projected activity for most reporting central banks through year-end also remains poised for rate cuts.


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So why is this so significant? Although the US is not actively increasing its accommodative monetary position, we clearly remain in one. The US has reaped the benefits of having a growing, albeit slow growing, economy. It makes our interest rates very attractive on a global basis, pushes demand for US products, and thus, impacts pricing and net yields.

Much recent talk has been made about the ever increasing foreign interest in U.S. municipal bonds. The truth is that the curiosity is the story. The idea that foreign investors are considering a spread product held almost exclusively by US investors speaks to the world state of interest rates. For US investors, the tax-exempt benefits afford individuals an ideal buy-and-hold way to protect capital and collect tax-free interest. International investors may benefit from taxable municipals or Build America bonds.

According to the U.S. Department of the Treasury (as of June, 2015), foreign long-term security holdings were approximately $16.202 trillion of which $6.655 trillion is equities and $9.547 trillion is bonds. Foreign investors continue to hold heavy interest in US Treasury securities at about 46% or $6.196 trillion. Putting this in perspective, SIFMA reports that the US Outstanding Bond Market Debt for the same time period was $39.873 trillion, meaning foreign held US bond debt is approximately 24% of the total outstanding.

What this means for US individual investors is that there may be a strong case to suggest that interest rates may not rise significantly higher anytime soon based on global rates and global monetary policies. The foreign demand for US securities alone may keep interest rates in check. Again we circle around to the idea that fixed income is purchased by many investors for long-term planning and not short-term speculation. This is a very different mind-set that is required versus that for portfolio growth assets. As I repeat so often, fixed income assets, for the hold-to-maturity investor, lock in cash flow, income and a date where face value is returned. Keep core assets and mind-set separate from speculative and/or growth assets.

 

Copyright Ā© Raymond James

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