While part of this rise can be attributed to the improving economy, the rise is also due to the expectation for accelerating inflation.
While higher yields translate to higher income for investors, it is important to look at yields not only on an absolute basis but on a “real” basis (i.e. the yield after subtracting the inflation rate). While higher yields on longer maturity bonds might be tempting at face value, we have generally limited our bond purchases to maturities in the three to seven year maturity range. Because bond prices fall as interest rates rise, longer maturity bonds have more price sensitivity. By “staying short” on the yield curve with regard to bond purchases, we can mitigate some of the price volatility in bond portfolios. If rates were to rise further in the future, we also have greater flexibility to take advantage of higher yields as shorter maturity bonds mature. Even as longer-term rates move higher, we do not expect short-term rates to rise very much in the near term. The Fed is not forecasting
an increase in the short-term federal funds rate until 2022 and perhaps as late as 2023. While they may need to reconsider if growth and inflation exceed expectations, they will also likely seek to prepare investors for this possibility well in advance of raising rates. Until then, we are focused on buying relatively short maturity and high quality government, corporate, municipal bonds and bond funds that offer a modest yield and principal protection.
