Would Fed Hikes be Bearish or Bullish for Bonds?

mikelarson-150The verdict is in, from the markets and economists. The Federal Reserve is closer to raising short-term interest rates at its December 15-16 meeting than at any meeting in almost a decade.

interest-rate-hikeSeveral Fed officials have said as much in recent speeches, and the minutes from the Fed’s late-October meeting confirmed they’re on the cusp of action. Many investors and average Americans assume a Fed hike would be bearish for Treasury bonds. But is that really the case?

The answer is: It depends!

First, let’s talk about WHICH bonds you’re talking about. The term “bonds” actually refers to Treasuries with maturities of more than 10 years. Very short-term Treasuries that mature in a year or less are called “bills,” while those that mature between one and 10 years in the future are called “notes.”

When the Fed “raises rates”, it doesn’t single-handedly raise every single rate in the marketplace. It raises the federal funds rate, which is an overnight rate at which banks borrow money from each other; and usually the discount rate, the rate at which banks borrow directly from the Fed on a short-term basis.

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Since those are very short-term rates, they have the most direct impact on very short-term Treasuries. The 2-year Treasury is particularly sensitive to current and future Fed moves. Anticipation of a Fed move helped drive the 2-year yield from as little as 0.2% a couple years ago to a five-and-a-half-year high of 0.89% in November.

10YR_TREASURY_CARTOON_08.19.2015_normalBut longer-term bonds can behave in an entirely different fashion. Why? Bond investors are very sensitive to long-term growth and inflation expectations.

If they believe a Fed hike NOW will help reduce growth and inflation LATER, then they may actually BUY more bonds when the Fed hikes.

That means long-term bond prices may go up and long-term rates may go down … even as short-term Treasury prices fall and short-term Treasury rates go up.

Confusing, I know.

But that’s why I’m here to help. I’ve produced an online educational course “How To Profit From Rising Interest Rates”, that is designed to help demystify the bond market. It will empower you with all the information you need to successfully navigate all kinds of interest rate environments, including this one. To watch the first session totally free, click here!

Until next time,

Mike Larson

Mike Larson is a Senior Analyst for Weiss Research, and is also the editor of Safe Money Report and Interest Rate Speculator at Weiss. A graduate of Boston University, Mike Larson formerly worked at Bankrate.com and Bloomberg News, and is regularly featured on CNBC, CNN, Fox Business News and Bloomberg Television as well as many national radio programs. Due to the astonishing accuracy of his forecasts and warnings, Mike Larson is often quoted by the Washington Post, Chicago Tribune, Associated Press, Reuters, CNNMoney and many others.