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Bond Playbook Ahead Of The Fed Rate Hike

Bond Playbook Ahead Of The Fed Rate Hike by Gene Tannuzzo, Columbia Threadneedle Investments

  • While we do not expect an interest rate hike this week, investors need to have their eyes wide open about what could happen, and what it means for bond markets.
  • While there are many possibilities for what could play out in the markets, we are focused on what we see as the three most plausible outcomes when assessing the future direction of policy.
  • As a simple rule of thumb, we would consider adding exposure in areas that succeed in two out of three scenarios, and reducing exposures to areas that are more likely to lose in two of three.

The FOMC will announce its decision on interest rate policy this coming Thursday. For the first time in many years, there is actually a tangible debate about whether the Fed will hike rates. While we do not expect a rate hike this week, investors need to have their eyes wide open about what could happen, and what it means for bond markets.

While there are many different possibilities for what could play out in the markets, we are focused on what we see as the three most plausible outcomes when assessing the future direction of policy. In Exhibit 1, we have identified these scenarios, along with possible winners and losers in the bond world.

Exhibit 1: What will the Fed do? Three scenarios.

Bond Playbook Fed Rate Hike

In building fixed-income portfolios, we would advocate focusing on sectors that can win in more than just the base case scenario. As a simple rule of thumb, we would first consider adding exposure in areas that succeed in two out of three scenarios, and reducing exposures to areas that are more likely to lose in two of three. This helps guide our focus towards adding exposures to investment-grade corporate bonds (IG) and mortgage-backed securities (MBS) lately, reducing exposure to international and emerging markets, and maintaining a preference for U.S. dollar denominated assets.

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