How the Fed’s monetary policy affects US fixed income investments
The Fed and fixed income
In the face of a recovering economy, the imminent end to the Fed’s monthly bond buying program and the future onset of monetary tightening, U.S. fixed income investors may have to seek portfolio alternatives. The Fed is expected to end its monthly bond buying program (currently at $45 billion per month) by fall this year. These purchases provide significant demand and price support for longer-term Treasury securities (TLT) and agency-backed securities (MBB) besides providing liquidity in the global capital markets.
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The Fed has also indicated that it would raise the Fed funds rate after the bond buying program ends. This is widely expected to occur between Q2 and Q4 2014. An increase in the base rate would also increase rates across the credit and maturity spectrum, all else equal. As interest rates and bond prices move in opposite directions, this would decrease the prices of U.S. bonds. International bond funds can help in diversifying this risk, as interest rates across countries usually don’t move in the same direction.
In the next part of this series, we’ll discuss developed market bond funds like the iShares International Treasury Bond ETF (IGOV), the Invesco PowerShares International Corporate Bond Portfolio (PICB), and the SPDR Barclays International Treasury Bond ETF (BWX).