The MAP

Monthly AIRE Perspectives – April 2022

Dear Friends and Valued Clients,

Please see below for The MAP – Monthly AIRE Perspectives for this month. Please make sure to review this each month!

NEW! By the Numbers

Attached to this email is a copy of By the Numbers (BTN), a weekly email publication that AIRE Advisors has subscribed to on behalf of our clients. We think you'll find it quite beneficial as a source of quick facts and data from the investment world that are great pieces of information for investors. We will post this weekly on our LinkedIn page and our upcoming Facebook page, and periodically share one or two bullet points in more detail on The MAP each month. Please connect with us on LinkedIn by clicking here. We will send out our upcoming Facebook and additional social media pages once they have been activated, which will be later this month.

Note that BTN is a copyrighted publication and that you are receiving it because of our business relationship. The email is for your entertainment and benefit and is not to be forwarded onto other individuals. Enjoy!

Focus: Inflation, Bonds and Interest Rates

From the attached “By the Numbers”, we would like to highlight items 3 and 4, relating to inflation:

It is clear that we have experienced unusual inflation during the past year.  There are many reasons that have been cited for why this has occurred, including an increase in money supply, rising oil prices as a result of the Russian invasion of Ukraine, supply chain issues and more.  While it is difficult to predict if and when inflation will subside to lower levels (many economists are currently predicting 1-2 years), our discussion here is not to speculate on future inflation levels, but to discuss interest rates and the impact of inflation on bond prices.

Let’s begin with the Fed, which raised the Federal Funds Rate in March from a target of 0-0.25% to 0.25-0.50%.  Given the current situation, we have often heard people ask us what we should do with bonds, given that rates are going to increase.  This, however, is an incorrect assumption, and warrants a brief explanation and understanding of how bond markets work.  The Federal Open Market Committee (FOMC) sets the Fed Funds rate, which is the rate at which the Fed suggests for banks to lend money to each other as needed on an overnight basis.  This is an overnight rate, and one that is set by the FOMC rather than directly by markets.  In the investing world, when we talk about interest rates, we are generally referring to bond market interest rates, which are not set by the Fed or any particular entity, but by supply and demand.

The demand for bonds can be impacted by many factors, including inflation, the Fed’s indications about future Fed Funds rate moves, and much more.  But, similar to the stock market, where current conditions and future predictions are priced in instantly, bond market interest rates change in anticipation of future “predictions.”  Over the long run, bond rates tend to move up and down with inflation.  If we have sustained high inflation for many years, we might see bond rates continue upward.  However, our experience has shown that the bond market tends to be very efficient, and prices in future inflation predictions.  When we talk about bond market interest rates, we are generally speaking about benchmark rates, which are the current interest rates on the 5-year, 10-year and 30-year treasury bonds (in addition to other maturities).  Short-term bond rates (less than one year) tend to move almost immediately with the Fed Funds rate.  Longer-term rates, however, such as the benchmarks mentioned here, act in anticipation of where the market thinks things are headed.

That is not to say that the bond market is always right, as those rates do continue to change with new information, but it is to say that future interest rates become impossible to predict, as bond rates move in advance of expected future moves in inflation and the Fed Funds rate.  To illustrate this, let’s show you the specifics:  here are the trailing 12-month low interest rates on the 5-year, 10-year and 30-year treasury interest rates compared to their rates today:

As you can see, when it comes to bonds, interest rates have already gone up substantially, to reflect inflation, as well as the market’s consensus predictions about the future of inflation. The 5-year treasury, in particular, has had an almost 5-fold increase in its rate during the past 12 months. This is why it is impossible to predict future movements in interest rates: the bond market prices in new information immediately. In fact, there is a study we often quote that shows a Wall Street Journal survey of economists, conducted every 6 months for the past 40 years, which asks a simple question: are interest rates on the 10-year treasury going to go up or down in the next 6 months? The predictions were correct only about one third of the time on a 50-50 guess. So the lesson here is: do not try to predict interest rates, because the market has already done that for us.

So, what is the answer when it comes to fixed income investing? We believe that the answer lies in the foundation of our message: it is about portfolio construction. Longer-term bonds perform better if rates stay the same or go down, as you tend to lock in a higher rate, while short-term bonds perform better if rates go up, as you get your principal back and can then re-invest at a higher rate. Given that there is no reliable way to predict interest rates, some strategies that could be more appropriate include:

• Laddering – buying bonds at different maturities, based upon your particular goals and time horizon.

• Diversification – by maturity date, issuer types, premium versus discount bonds, and more.

• Periodic Purchasing – buying at different points in time to diversify your entry dates. For example, we have bought some high quality intermediate term municipal bonds recently at rates above 4% tax-free. These rates have gone up from about 2.5% just a few months ago. So we take advantage of the increase, but leave additional funds in short-term paper in case rates go higher in the future.

The ultimate message here is that the best practices in bond investing are similar to the best practices in stock investing, in that the main concern should be each person’s financial goals, time horizon and risk tolerance, rather than a prediction on the future direction of interest rates. We will be presenting a more comprehensive webinar on fixed income markets in the near future, and will keep you posted. If you have further questions on this, please feel free to contact us at any time.

Once again, we would like to thank you for your trust and loyalty, and look forward to speaking with you in the upcoming month. 

The commentary and opinions expressed in our articles on this page reflects the personal opinions, viewpoints and analyses of the AIRE Advisors, LLC employees writing the article. The articles on our website should not be regarded as a description of advisory services provided by our firm or performance returns of any AIRE Advisors, LLC’s clients. Any past performance discussed in these articles is no guarantee of future results. The views reflected in the articles are general in nature and made to provide education about the financial industry. These views and opinions are subject to change without notice. Any mention of a particular security, sector, and related performance data is not a recommendation to buy or sell that security or in that sector. Our firm manages client accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the articles. To determine what kind of investments may be appropriate for you, please consult your financial advisor prior to investing. Also, please note that all investing involves risk and the possible loss of principal capital.

In addition, AIRE Advisors, LLC may provide links hyperlinks for your convenience to websites produced by other providers of industry related material. Accessing websites through links directs you away from our website. Our firm is not responsible for errors or omissions in the material on third party websites and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.