2015 Midyear Bond Market Update

When will the Federal Reserve raise interest rates? How concerned should bond investors be over challenges in municipalities like Chicago and Puerto Rico? Wealth Management Insights sat down with Senior Fixed Income Research Analysts Craig Elder, author of Baird’s “Fixed Income Weekly,” and Dave Violette, author of Baird’s “Municipal Bond Market Weekly,” at the year’s halfway point for their insight into what’s in store for the market.

What you should know:

  1. Don’t obsess over the action – or inaction – of the Federal Reserve.
    • The media has been asking “When will they raise rates?” at every Fed meeting since 2010. The question of when the Fed will raise rates will likely be less important than how.
    • Know that the Fed traditionally responds to the market – and not the other way around. Investors may be better served focusing on market behavior than FOMC minutes.
    • “Ignore the noise and predictions and think about the reasons to have certain bonds in your portfolio,” recommended Violette. “By matching your portfolio cash flows to your obligation cash flows, you become less dependent on what happens to the markets.”
  2. Don’t read too much into highly publicized events.
    • The U.S. market often moves hand-in-hand with other world markets. For example, when yields on the German bund went from 5 basis points up to 100 basis points, U.S. yields moved right alongside them.
    • The potential for Puerto Rico to default on its municipal bonds or for Greece to further complicate the eurozone’s economic recovery is real, but trying to predict the lasting impact of such a move could be counterproductive.
    • “I think Puerto Rico in particular and municipal credits in general are idiosyncratic,” Violette said. “I don’t expect any kind of widespread defaults given the current conditions.”
  3. Look carefully at the unique benefits and risks of fixed income.
    • Consider your tax bracket. Treasury bond investors in a higher tax bracket may want to consider the potential double- or triple-tax exemption of municipal bonds.
    • Remember why you’re investing in bonds. Reaching for extra yield may expose your portfolio to risk you’re unprepared for.
    • “Investors should be asking, ‘Am I comfortable with the risk I’m taking in the portfolio?’” advised Elder. “Most investors can live with some duration risk and credit risk, but they can’t live with default risk.”

What you should do now:

From pension defaults to interest rate hikes to the threat of Greece’s exit from the eurozone, fixed income investors have been bombarded with scary headlines. Awareness of these issues can be beneficial – if they don’t lead to overreaction. Your Baird Financial Advisor can provide you with some valuable perspective into interpreting the latest movement in the fixed income market.