The Outlook For Investing in U.S. Treasury Bonds in 2017
Economists expect the Fed to raise interest rates four times in 2017. If this was to occur, the 10-year Treasury yield could rise up to 3.5% in 2017.
During the Great Recession nearly a decade ago, when the Fed reduced the base Fed rates to nearly 0%, the low interest rates made Treasury bonds relatively unattractive and the stock market and other investments comparatively more attractive. Now that the Federal Reserve (Fed) has made it clear that it intends to “gradually” raise interest rates, investors are likely to start moving money from stocks into Treasury bonds, which will in turn cause the bond prices to go up.
Interest rates have been on the rise since the summer of 2016. In doing so, they have influenced other leading assets, like stocks, gold, commodities, and currencies. The greatest challenge to understanding where the markets are going is to identify which asset has the strongest movement, and then determine how that move could impact other assets like bonds. For example, at the moment rising Fed interest rates are negatively impacting gold, supporting a strong dollar, and positively influencing financial stocks — such as banking stocks, insurances, etc.
In order for a bond to remain competitive as an investment vehicle, the yield on that bond needs to be attractive enough to make investors want to buy it. As such, when bond investors see that the Fed is raising rates, or if they expect the Fed’s interest rates to rise, they will begin “bidding up” higher bond yields. The opposite holds true when investors expect rates to fall. Keep in mind that political uncertainty, the rising dollar, global growth challenges, demographics, and weak U.S. productivity could cause rates to hold or even drop in 2017.
Bond yields have a direct correlation with current Fed interest rates, and also with anticipated future interest rate hikes. For this year, economists expect the Fed to raise interest rates four times in 2017, which would leave the fed funds target range at between 1.50% and 1.75% by end-2017. If this was to occur, the 10-year Treasury yield could rise up to 3.5% in 2017.
From a portfolio diversification perspective, bonds will always hold a valuable position in any well-constructed portfolio, and will always be regarded as a good, low-risk investment option. My only caution is that being a bond investor requires you to always be proactive, and keep yourself one step ahead of other bond investors. Waiting until the next Fed rate hike before you act could prove to be a costly mistake.