Are Interest Rates About To Explode Higher?
/Top Of Mind...
Interest rates hit a high this past week that we haven't seen in 4 years.
The 10-year Treasury yield climbed to 2.64% this week, which is higher than it has been at any point since 2014. This is the annual interest rate an investor would earn if they bought a 10-year U.S. Treasury bond today. Take a look...
(chart created via stockcharts.com)
This is a pretty important development given that long-term rates have failed to get back to pre-recession levels ever since 2009. As the above chart shows, in the past five years rates have quickly fallen anytime they approached a certain peak (the pink, dashed line). The same fate could happen again here, but I suspect we may finally start to see real increase in long-term rates after a decade of dormancy.
What does this mean? There are a few implications if long-term rates do, in fact, move higher. For one, it means bond values will go down. Second, it could spell more positive returns for the Financials sector, as banks and other firms that lend generally benefit from higher interest rates. Third, it means more expensive financing for things like home mortgages and car loans.
How this affects us: As you know, most accounts own some amount of bonds to help diversify from stocks. We would likely migrate away from Treasuries or other bonds that possess similar characteristics, such as investment-grade bonds, which we sold this past week. It could mean sitting in cash for a period of time in the event there isn't another type of bond we feel is worth owning.
We continue to own high-yield bonds in most accounts, which are a very different breed than Treasuries. I suspect high-yields will not be immune from an increase in Treasury rates, but the negative impact on high-yield bonds should be dulled compared to "safer" bonds like Treasuries.
We will continue our analysis, see what the next week brings and act accordingly.
In The Market...
The S&P 500 gained +0.9% this past week. Let's look at how the individual sectors performed:
(price data via stockcharts.com)
Another week of gains for the S&P 500, which is quickly up +5% in just three weeks to start the new year. This most recent week was more flawed though, as four of the six sectors were negative on the week. Two sectors we are looking to buy next week are Financials (XLF) or Consumer Staples (XLP). Financials continue to trend nicely higher, while Consumer Staples appear on the cusp of a new rally.
As alluded to earlier, it was another down week for Treasury bonds, which fell for the 3rd-straight week. If bonds are going to fight off this rise in interest rates then investors will need to show up soon ready to buy.
We will likely make some modifications to our bond fund lineup as well in the coming weeks. TD Ameritrade amended their list of commission-free funds, which are the ones we try to use when appropriate. I have to dig in and research the new list, but if you have any questions feel free to ask. My hope is to find a buffet of funds that are comparable to the previous ones and use those so-as to escape incurring transaction costs.
In Financial Planning...
There is one change within this year's tax reform that I had not previously touched on but is probably worth mentioning. The ability to "recharacterize" a Roth IRA conversion is no more.
A Roth IRA recharacterization is the act of undoing a Roth conversion (something I wrote about a few weeks back here). It reverses the process of having turned a Traditional IRA into a Roth IRA, and along with it reverses the tax burden you would be subject to pay on the balance converted. Many people do this if, for example, their income ends up being much higher throughout the year than they anticipated. They would rather wait for another year than pay a higher tax percentage now on the converted amount.
The old rules allowed you all the way until Oct. 15th to undo a Roth IRA conversion that stemmed from the previous tax year. Now, you cannot do them at all. I highlight this particularly because we will sometimes recommend that clients convert a portion (or all) of their tax-deferred IRA balance into a Roth, whether because they are having an unusually low earnings year or because it simply makes sense to have those funds grow tax-free. Moving forward, there are no do-overs once that decision is made.
In Our Portfolios...
What's New With Us...
I will be ramping up my hiring search for a Chief Compliance Officer in the coming weeks. If you are curious to know more about the position or what I am looking for in a candidate, just ask.
Have a great weekend!
Brian E Betz, CFP®
Principal