Bernanke, Bonds and You

With all this talk about the Debt Ceiling, what does it mean for bonds and interest rates?

Republican Congressional leaders recently proposed a three-month Federal debt limit extension. This is economically significant as it separates raising the debt ceiling from federal spending cuts.

At the very least, the possibility of a federal government shut down amid concerns about not paying U.S. Treasury interest has been postponed for three more months.

The Federal Reserve (the Fed), our nation’s bank, has been buying a large amount of bonds for the past few years. This has kept interest rates low. While this may be bad for bond investors dependent on interest income, it may be good for our economy as a slow recovery takes hold. But no one’s really sure if the bond-buying programs are helping the economy. We have had very low mortgage rates, yet unemployment remains above 7% while consumer spending and residential housing have seen only modest gains off severe lows.

There has been increasing speculation that interest rates will rise in the not-too-distant future, and when they do, they may have a serious impact on investment psychology. Bonds have an inverse relationship to interest rates -- as interest rates increase the price/value of individual bonds drops. If bonds are held until
maturity, investors will typically receive the expected rate of return, i.e.,
the interest (or coupon) rate on the bonds. When the Fed's practice of quantitative easing (QE) ends, an increase in interest rates would
come as little surprise; however Bernanke has given no indication that he will
raise rates in the near future.

We are in a slow-growth recovery. Since the end of World War II annual US economic growth has averaged 3.5%. Since 2007, growth has been under 2% and there’s little on the horizon to suggest that may change in 2013. “We have found this [bond buying] to be an effective tool," Federal Reserve Chairman Ben Bernanke recently said. The Fed will "continue to assess how effective [it is]." The interpretation? He will change course if economic conditions change, but until further notice, we should be staying the course.

Edward J. Kohlhepp, CFP®, ChFC, CLU, CPC, MSPA

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Investment Advisory Services offered through Kohlhepp Investment Advisors, Ltd., a Federally Registered Investment Advisor. Securities offered through Cambridge Investment Research, Inc. a Broker/Dealer, Member FINRA/SIPC. Kohlhepp Investment Advisors, Ltd. and Cambridge are not affiliated.

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