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Investing in a Rising Rate Environment

Executive Summary

It’s been an extended period of low interest rates. The federal funds rate has remained between 0.0% and 0.25% since December 2008. But as the U.S. recovery continues, interest rates are likely to trend higher.

Treasury yields have trended lower since peaking at the end of 2013 on heightened geopolitical risk and signs of slower growth in the U.S., Europe, and China. 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 restrain returns.

We have tools that can help you understand the current environment, as well as what might be different this time, so 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, 2016

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

Opening Quote Amid a tightening U.S. labor market, the Federal Reserve aspires to move policy rates higher. Closing Quote
Ted Wiese, T. Rowe Price Head of Fixed Income

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, and 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 Barclays Treasury Long Total Return Index, international bonds by the Citi World Government Bond Index Non-USD USD, core bonds by the Barclays U.S. Aggregate Bond Treasury USD, U.S. Corporate Bonds by the Barclays U.S. Credit Index, multi-sector bonds by Barclays Global Aggregate Treasury USD, short-term bonds by Barclays U.S. Govt/Credit 1–3 Yr Treasury 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 03–2014) 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 for MSCI data: MSCI. 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.
Source: Morningstar Direct

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, 2016

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.

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