What’s Really Risky About Interest Rate Risk

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Municipal bond investors who fear interest rate risk should keep this figure in mind: $14 trillion.

That’s the amount of global debt currently being held that has a negative yield. In other words, investors around the world are paying institutions for the privilege of holding their money.

Interest rate risk is misplaced

For those investors reluctant to add to their municipal bond holdings and fear interest rate risk, this negative yield environment should prompt second thoughts. Their concern – that interest rates will make a sudden U-turn and rise steeply – seems badly out of step with reality.

What's really risky about interest rate risk

In the U.S., the Fed signaled its outlook on the economy by cutting the benchmark rate twice already this year. Once in July – the first in more than a decade – and again last month, and it’s considering two more cuts in 2019.

The Fed sees what’s obvious to average investors: Persistent trade battles, a slowdown in manufacturing and a drop-off in hiring and investment.

There’s also the inverted yield curve, which generally presages an economic downturn (“Muni Strategy Amid the Inverted Yield Curve”).

Overseas, signs are even more ominous. The major economies of China and India are slowing. Japan’s exports are down for 10 straight months and Europe is sliding into recession. Meanwhile, the European Central Bank is renewing its quantitative easing program in another attempt to jump start growth.

And there’s that $14 trillion of global debt with negative yield.

Fear rates going in the other direction

Interest rates will fluctuate at some point, but investors searching for a reason to be concerned should be on the lookout for rates to continue their slide, not suddenly skyrocket.

Investors paralyzed by interest-rate risk probably remember years when rates were much higher. But long memories cut both ways. Rates were indeed higher, but a simple chart tells an even bigger story: Long-term rates have been heading down for almost 40 years.

As longtime clients and friends know, we don’t believe investors have to fervently follow the twists and turns of economic news to succeed in the municipal bond market.

They simply need to focus on the most important aspect of muni investing. The real risk is trying to outguess the market and missing out on a steady stream of tax-free income.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Oct 24, 2019

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.