Navigating Interest Rate Volatility

12-18-2023

INTRODUCTION

Imagine standing in a sun-drenched marketplace as a weary traveler. Two options beckon: an iced glass of lemonade offering immediate refreshment or a sturdy canteen promising a steady flow of hydration for the journey ahead. The recent pivot in the Federal Reserve's monetary policy poses a similar dilemma for fixed income investors. While high short-term yields may tantalize with their instant sweetness, a closer look reveals the potential for dehydration down the road.

THE FED'S U-TURN

After one of the most aggressive rate hiking cycles in US history, the December Federal Open Market Committee (FOMC) meeting delivered a notable shift in policy stance. With inflation approaching the Fed’s 2% target and growth slowing, the central bank unanimously decided to hold rates steady and signaled a change in focus towards when to begin cutting rates. The median FOMC member is now expecting a 0.75% reduction in the fed funds overnight rate in 2024, or the equivalent to three 0.25% rate cuts that may begin as early as March. Longer-term expectations are now for short-term rates to approach 3% by the end of 2026.

NAVIGATING REINVESTMENT RISK

The current bond market landscape presents an inverted yield curve, where short-term Treasury bond yields outpace longer-maturity yields. This scenario raises critical questions about investment strategies: why consider longer-term bond strategies when seemingly lower risk short-term Treasuries, CDs, and money market funds can potentially offer higher yields?

The answer lies in the complexities of reinvestment risk, which is often overlooked in conventional market assessments. Reinvestment risk is the possibility that future reinvestment of bond maturities might yield lower returns than the original positions. While yields on cash-like investments appear attractive now, future reductions in interest rates by the Fed would reduce reinvestment opportunities, thus impairing future returns.

LADDERING INTO LONGER-TERM SUCCESS

Instead of pursuing the fleeting appeal of short-term yields, our advocacy leans toward a more strategic approach to managing surplus savings. Emphasizing long-term stability and sustained wealth creation remains paramount, and high-grade credit markets have emerged as an ideal solution. At Kovitz, our emphasis lies in delivering yields that surpass benchmark rates through meticulously crafted bond ladders, providing a shield against the volatility of interest rate swings.

·       Mitigating Rate Fluctuations: By strategically laddering maturities, we ensure reinvestment flexibility. As bond maturities arrive, we can opportunistically capture higher yields if rates rise. Conversely, should rates fall more than expected, your portfolio benefits from a significant portion of bonds locked into previously attractive yields.

·       Compounded Returns over Time: Our laddered approach prioritizes consistency and compounding at rates of return greater than cash. By minimizing exposure to volatile short-term fluctuations, we focus on the steady accumulation of wealth over longer horizons.

·       Adapting to the Evolving Landscape: The ladder's inherent flexibility allows for dynamic adjustments based on market shifts. We continuously monitor and fine-tune client portfolios, ensuring optimal navigation through even the most unpredictable terrains.

CONCLUSION

While the immediate allure of high short-term yields may be tempting, we prefer a bond ladder strategy that takes advantage of current yields that remain near two-decade highs while mitigating reinvestment risk associated with further interest rate declines projected by the Fed. In this dynamic landscape, the shot of short-term rates may offer a burst of sweetness, but the sturdy canteen of a laddered bond strategy promises a sustained flow of hydration for your financial journey.

DISCLOSURES

Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. The information and opinions expressed in this publication are not intended to constitute a recommendation to buy or sell any security or to offer advisory services by Kovitz. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to participate in any trading strategy, and should not be relied on for accounting, tax or legal advice. This report should only be considered as a tool in any investment decision matrix and should not be used by itself to make investment decisions.

Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. The description of products, services, and performance results contained herein is not an offering or a solicitation of any kind; always consult with your tax advisor. Past performance is not an indication of future results. Securities investments are subject to risk and may lose value. Kovitz shall not be responsible for any loss sustained by any person who relies on this document.

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