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Investing in a Rising Rate Environment

Executive Summary

Earlier this year (2017), the Federal Reserve’s Federal Open Market Committee announced an increase in short term interest rates. Specifically, the Fed stated that it was raising the target range for the overnight federal funds rate between 0.75% and 1.00%. This is an increase from the 0.50% to 0.75% range that the Fed established in December 2016. As U.S. growth improves, interest rates are likely to trend higher as the Federal Reserve begins to normalize monetary policy.

In this environment, we believe some asset classes are in a better position than others to outperform as rates rise. The prolonged stretch of strong returns in fixed income investments is likely coming to a close. Equities are more likely to benefit from economic recovery, but there are several factors that could constrain returns.

We have tools that can help you understand the current environment, as well as what might be different this time, so that you can guide your clients through changing conditions.

The Extended Period of Low Interest Rates May Be Coming to a Close

Federal Funds Policy Rate Level

As of March 31, 2017

Source: J.P. Morgan
Generally speaking, the dark blue represents a neutral stance, gray represents restrictive, and orange represents accommodative.

Opening Quote The Fed is committed to a gradual hiking cycle. Closing Quote
Andrew McCormick, Head of U.S. Taxable Bonds

Equities Led the Markets

  • Historically, some asset classes performed better than others when rates rose.
  • Traditional, longer-duration fixed income has been the most sensitive to rising rates.
  • Nontraditional fixed income and yield-oriented equity provided yield with less sensitivity to rate increases.
  • Growth and international equities tended to outperform in rising rate environments. 
Asset Class Performance in Periods of Rising Interest Rates
In the Past...
  • Traditional, longer-duration fixed income has been the most sensitive to rising rates.
  • Nontraditional fixed income and yield-oriented equity provided yield with less sensitivity to rate increases.
  • Growth and international equities tended to outperform in rising rate environments.

Past performance cannot guarantee future results.
Chart depicts average annual returns for the following periods of rising rates: 4/79–3/80, 10/80–9/81, 6/83–5/84, 10/86–9/87, 11/93–10/94, 2/99–1/00, 6/03–5/04, 7/05–6/06, 1/09–12/09, 9/12–8/13. Periods of rising interest rates represent 12-month periods that saw the largest increases in 10-year Treasury bond yields within broader periods of rising rates.
Long-term Treasuries are represented by Bloomberg Barclays Treasury Long Total Return Index, international bonds by Citi World Government Bond Index Non-USD USD, core bonds by Bloomberg Barclays U.S. Aggregate Bond Index, U.S. corporate bonds by Bloomberg Barclays US Credit Treasury USD, U.S. corporate bonds by Bloomberg Barclays U.S. Credit Treasury USD, multi-sector bonds by Bloomberg Barclays Global Aggregate Index, short-term bonds by Bloomberg Barclays U.S. Govt/Credit 1–3 Yr. Treasury USD, U.S. corporate high yield by Bloomberg Barclays U.S. Corporate High Yield TR USD, floating rate by S&P/LSTA Performing Loan Index (Total Return), multi-alternative strategies by Hedge Fund Research, Inc.’s HFRX Global Hedge Fund Index (Total Return) (HFRGH) (April 3, 2014) and Hedge Fund Research Inc.’s Regional Investment Focus Fund of Funds Index 1989–2003, world commodity by S&P GSCI TR, infrastructure by UBS Global Infrastructure & Utilities Index (Total Return), U.S. large-cap value by Russell 1000 Value Index, international stocks by MSCI EAFE Index GR USD, U.S. large-cap growth by Russell 1000 Growth Index.
Source: Morningstar Direct.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.
Bloomberg Index Services Ltd. Copyright© 2017, Bloomberg Index Services Ltd. Used with permission. 

Going Forward, Returns May Be Moderate

U.S. Equity Market Performance

Largest 12-Month Increases in Yield on the 10-Year U.S. Treasury Note July 31, 1973‒March 31, 2017

Past performance cannot guarantee future results.
Source: FactSet

Learn More

Request a copy of our Rising Rates presentation to enhance your clients' knowledge of the potential impact of rising interest rates, including historical data and tax implications of investments.

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action. The views contained herein are as of December 2017 and may have changed since that time. Past performance cannot guarantee future results. All charts and tables are shown for illustrative purposes only. Expressions of opinions are those of the author(s) and are subject to change without notice.

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