6 Tips to Prepare for Falling Interest Rates

By Rusty Vanneman, CLS Investments

The Federal Reserve (Fed) is predicting two more rate hikes in 2017, and that has many investors weighing the potential pros and cons of a rising rate environment. But, there are many reasons to believe interest rates could fall.

The stock market is overvalued, and currently in a mature bull market, so it could easily correct. Uncertainty over fiscal policy in the Trump administration could sink inflation expectations, and the economy could certainly slow. Global rates remain lower than domestic rates, and investor sentiment is so one-sidedly negative right now, it might not take much for rates to start falling.

So, if they do, are your portfolios prepared? Below are six tips to help you be ready for whatever direction rates may go.

1) First, define the terms. What is the definition of an “interest rate environment”? Does it mean short-term rates the government/Fed controls? Does it mean long-term rates that market forces determine? Does it mean Treasury bonds? Corporate bonds?

The bond market is way more complex than overnight rates, 3-month bills, or even 10-year Treasury yields. Like the stock market, the bond market comprises a lot of levers for active managers to pull when making investment decisions, trying to enhance portfolio returns, and managing portfolio risks.

Defining an “interest rate environment” by the Fed’s controlled federal funds rate is arguably the best method (but yes, that’s debatable). In this case, the definition is simple: What move did the Fed make last? The Fed is increasing short-term rates. Thus, by this definition, we are in a “rising rate environment.”

Defining it by longer-term rates is trickier, and it depends on the time frame. Some investors prefer three months, and in that case, 10-year Treasury yields are in a “falling rate environment.” If we look at the 1-year time frame though, rates are rising.