Investors are concerned as the Fed tapers and inflation rises
Posted By RichC on October 16, 2021
A friend contemplating rolling over his 401K to an IRA asked me a bond investing question the other day as he would like to balance his portfolio of stocks by adding some bonds after the rollover. Since he has never owned a bond (outside of a managed fund), the question was, “what’s the impact of the Federal Reserve ‘tapering’ and what does it have to do with yields and bond prices?”
Chart of US Treasury 10-Bond
U.S. Treasuries are front and center (10-year bond chart from MacroTrends above) and the Fed “tapering” means that they will not be buying the $80 Billion every month in the future. Economics 101 teaches us (as does history), that Treasury Bond yields are impacted by “supply and demand.” When a big buyer like the Fed cuts back on their buying, then yields on bonds like the 10-year note will rise to attract more buyers. The challenge for those owning or buying older bonds with lower yields is that they are no longer attractive on the secondary market and therefore must be discounted to sell. As this tapering continues and the Fed ponders or changes their lending rates to banks next year … buying yesterday’s and today’s issues become less attractive.
So the plan of adding bonds to your portfolio for security and investment balance in a volatile or rising interest rate environment can be tricky. My advice is when adding bonds as interest rates rise is to keep the durations shorter (1-3 years). You really don’t want to lock into low 10-year yielding bonds when inflation rises as their relatively low return may not keep up with rising costs.
Tidbit: Even TIPS (Treasury Inflation-Protected Securities) can be risky because even though their interest rates rise with inflation, the government’s CPI (basket of goods) isn’t always reflective of overall true inflation.
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