Lately, it seems there is no safe place for your money.
Commodities, stocks, and even bond prices swing every day. Bonds are supposed to be safer than equities, but with this level of volatility it doesn’t seem to be the case. If you’re holding a bond fund in your portfolio, especially one with a long duration, your wealth is much smaller. If you held a 20-year TIPS fund, it would be down 22% since January! It’s disconcerting to say the least. Savers are normally encouraged to invest in bonds to limit their risk exposure. But rising yields will ultimately be good for savers and the economy as a whole.
Historically, bond yield means revert—they fluctuate around an average, higher (than the current) rate. The stock market can go up forever; no one knows what the S&P will be in 15 years. But bond yields normally move within a narrower range and will probably not go very negative for long, because who’d pay someone 10% to lend money? There’s a limit on how high bond prices can rise. Bond yields are influenced by Fed policy, (the extraordinary interventions in the last few years aside) but further out on the yield curve, bond prices are a market price, reflecting the risk of default, the price and availability of other similar assets, and institutional factors (in the UK pension funds hold lots of long-dated gilts). It’s not the Fed’s job, nor should it be, to artificially depress the entire yield curve for long—otherwise that may lead to speculative bubbles, market distortions, or other unintended consequences. The rise in interest rates is in many ways inevitable and consistent with the mean reverting behavior bonds normally display.
While lower rates are supposed to lower the cost of investment and boost the economy, lower rates also happen to be bad for savers because lower rates mean smaller returns. The impact of rising rates depends on your age and portfolio composition: If you have heavy bond exposure, your portfolio will take a big hit when rates rise, but you’ll earn higher yields once rates stabilize.
A higher rate environment benefits younger savers. A recent study from the Employee Benefit Research Instiitute shows that if rates stayed low, the chance of not having enough for retirement increases significantly for those born between the 1960s and 1980s. They only considered young people with private pension accounts but their results extend to other assets, like the viability of defined benefit plans. From a retirement saving perspective, rising rates will be good for savers of a certain age. That assumes young people have significant retirement assets, which many don’t. Most of the middle-aged population has its wealth in housing, and rising rates means more expensive mortgages. But that alone is not a reason to keep rates low.
There should be more incentives to save for the long run and hold assets other than housing. Less leverage and more diversification are the lessons we should have learned from the financial crisis. They increase the stock of investable assets that leads to more long-term economic growth. Indeed, higher rates typically lower demand by discouraging consumption, which given the weak recovery is a serious concern. But that relies on a model that presumes higher saving rates. If saving rates are near zero, there’s not as much scope to boost consumption through low rates (unless the objective is to encourage people to take on more debt and they may be credit constrained).
The reasons behind rising rates and the ideal timing of Fed policy is up for debate. But it would be a mistake to view a steepening yield curve as a problem.
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