Financial experts say investors need to reevaluate their bond portfolios as the Federal Reserve lowers interest rates. Bond prices and market interest rates typically move in opposite directions, which can cause certain parts of the bond market to rise. Investors may consider corporate and municipal bonds while shifting toward long-term assets.
Investors will need to rethink their bond portfolios as the Fed lowers interest rates, and the Fed’s dovish policy could help.
The central bank began its first easing campaign in four years with a 50 basis point rate cut in September, bringing the policy rate to a range of 4.75% to 5%.
After last week’s better-than-expected jobs report, analysts are predicting that future interest rate cuts may be smaller.
But experts say the Fed’s policy shift could be good for some parts of the bond market. Bond prices and market interest rates typically move in opposite directions.
“This is a great time to take another look at bonds,” said Scott Ward, a certified financial planner and senior vice president of complex planning in Birmingham, Alabama.
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In 2022 and 2023, the Fed implemented a series of rate hikes that increased yields on savings, money market funds, certificates of deposit, and other options.
It may be tempting to hold on to cash, but “as interest rates fall, cash becomes less attractive and less productive,” Ward says.
He said long-term investors can “get more from the safer side of their portfolio” by using bonds.
According to financial advisors, there are several options to consider.
corporate bond
Ted Jenkin, CEO and founder of Atlanta-based oXYGen Financial, says mid- to long-term corporate bonds may be considered in an environment of falling interest rates.
The Morningstar U.S. Corporate Bond Index, which measures investment-grade corporate bonds, returned 5.8% in the third quarter of 2024, outpacing the broader bond market’s 5.2%.
Ward said many companies took advantage of rock-bottom interest rates to shore up their balance sheets and refinance debt during the pandemic.
“Businesses will come out of this rate hike cycle in pretty good shape,” he said.
local bonds
Municipal bonds may become more attractive, especially among residents of high-income tax states, as investors brace for possible future tax increases.
Interest on municipal bonds is federally tax-exempt and can avoid state taxes if you live in the issuing state. Municipal bonds typically have lower default risk than corporate bonds.
“If the Fed continues to cut rates, long-term municipal bonds should do better,” said Jenkin, who is also a member of CNBC’s Financial Advisory Council.
Mr Ward said: “Municipal governments have some great characteristics for long-term investors, including a combination of attractive yields and low risk profiles.”
Advisor extends the “term” of the bond
When constructing a bond portfolio, advisors consider duration, which measures a bond’s sensitivity to changes in interest rates. The duration formula, expressed in years, includes the bond’s coupon, time to maturity, and yield paid over the period.
Some advisors began extending the duration of bonds before the Fed’s first rate cut in September.
Jenkin said his firm began transitioning to “intermediate duration” bonds, defined as five to 10 years, about four months before the Fed’s first rate cut.
Experts say these longer-maturity bonds should benefit investors as interest rates fall.
