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Ryan Nauman
VP, Product and Market Strategist
Stephen Berei
VP, Client Services & Implementation
Jeremy Poulin
Senior Client Consultant

Revisiting the last Rising Interest Rate Environment

Dec 2, 2015 Ryan Nauman

With an unprecedented period of easy money coming to a close and interest rates set to rise, it’s important to revisit how the bond market performed during the Fed’s most recent rising-interest-rate regime a decade ago. Only time will tell if history repeats itself, but using the past as a guide, now may be the time for advisors to take a closer look at their fixed income allocations.

The Fed’s last stretch of rate hikes occurred June 2004 - June 2006, during which time the federal funds rate was gradually raised from 1.25% to 5.25%.

Based on the Fed’s cautious assessment of U.S. economic conditions over the past year, one can assume they may take a similar approach to tightening monetary policy over the next economic cycle to reach their target rate. 

With this in mind, it’s important for advisors to reassess their client’s fixed income allocations, whether it’s creating a bond ladder, reducing the duration of holdings or making other adjustments to ensure a well-diversified portfolio.

So, using history as a guide, which fixed-income assets performed best during the last rising rate environment? 

Below in figure 1 are eight common fixed income asset classes. We have taken their corresponding indexes and displayed their performance (figures 2 and 3) and correlations (figure 4) during the most recent cycle of rising rates.

Figure 1

All eight asset classes ended in the black after this 25-month period (figure 2). The high-yield asset class, measured by the BofA Merrill Lynch US High Yield index, was the clear winner, returning an annualized 8.05% during this time period (figure 3). The next closest asset class was Municipals (Barclays Municipal Bond index), producing a 4.49% return. Global bonds (Barclays Global Aggregate) followed with a 3.81% return while short-term bonds lagged all others, returning 1.98% (figure 3).

Figure 2

Figure 3

It’s also worth noting the relationships between these assets. Figure 4 shows high-yield bonds (BofA Merrill Lynch US High Yield index) and global bonds (Barclays Global Aggregate index) had very low correlations compared to the other asset classes. Short term bonds (BofA Merrill Lynch 1-3 Year US Corporate & Government Index) also had relatively low correlations to other asset classes.

Figure 4

A lot can happen in 10 years. While it’s impossible to know if history will repeat itself, it’s important to understand how different fixed-income classes performed during the last rising-rate cycle and consider whether they are the right fit for client portfolios going forward.

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