Protect Yourself Against Higher Rates

While Donald Trump’s election as the next President has been good for stock prices, for bond prices, not so much.

While it’s impossible to know exactly what policies President-elect Trump will put into place, what he’s talked about could spur higher inflation and interest rates, and higher rates mean lower bond prices.

Other factors also point to higher interest rates: Fed Chairwoman Janet Yellen testified before Congress this week that a rate hike could come relatively soon—perhaps as early as next month. Plus the housing market is performing well; applications for unemployment aid is at a 43-year low; and consumer prices are ticking up.

So now would be the time to add floating rate bonds to your portfolio. Such bonds maintain their value well when rates rise, while letting you enjoy bigger interest payments from those higher rates. As an example, iShares Floating Rate Bond (NYSE: FLOT) holds a portfolio of bonds whose coupon rates periodically “reset,” usually on a quarterly basis. While it’s yield is a paltry 1% now, as those resets occur both its payouts and the value of the bonds themselves will rise.

A dozen or so floating rate mutual funds and exchange-traded funds are available, and they’re pretty similar. The criteria to look for first is expense ratios: ETF’s shouldn’t charge more than 0.20% (FLOT charges 0.20%), while mutual fund’s expense ratios shouldn’t top 0.70%.

Much of the recent rise in interest rates has been in anticipation of Trump policies, such as investing in American infrastructure, not the least of which is his pet border wall project. Such public spending would be the equivalent of a massive stimulus program, and economists were already forecasting that GDP growth could hit 2.2% next year and 2.3% in 2018, well above the 1.5% growth we’ve seen over the past year.

On top of that, economists also predict that inflation will run about 2% both years, which if  correct would be the most sustained stretch of inflation since the recession.

On top of the potential stimulative effects of a massive infrastructure program, the Federal Reserve is also likely to become much more hawkish under President Trump. He’s been critical of the Fed in the past, saying its easy money decisions have created “big fat ugly bubbles.” Right now there are two vacancies on the Fed’s seven-member board of governors and I suspect Trump will appoint hawks to those chairs. Yellen’s term on the board, plus Vice Chairman Stanley Fisher’s, both expire in 2018 and will also almost certainly find more hawks perched in those seats, especially if the midterm elections break for Republicans.

With a more hawkish Fed and the stimulative effect of infrastructure and tax cuts, I don’t see the current easy money policies lasting much longer. The yield curve is already steepening as yields are rising on long-dated bonds and falling on short ones. That’s caused the biggest spike in mortgage rates in more than three years, hitting 3.94%, and they’re likely going to continue moving higher.

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