Economists Wrong Again
by D. Tyler Vernon
In 2018 the US economy experienced a series of interest rate increases. December of 2018 marked the worst December on record as measured by performance of equity markets partially due to concerns that the Federal reserve would continue to increase interest rates higher in 2019. At the end of 2018, the 10-Year Treasury bond stood at a 2.7% yield. Consensus among professionals was that interest rates would continue to rise as a result of an improving economy and further US wage gains.
The Philadelphia Fed’s survey of professional forecasters, a poll of about 40 leading economists, predicted interest rates would be 2.9% by June 30th. Fast forward to that time. The actual yield on a 10-year Treasury bond as of the end of June was 2.0%. Not only did rates not rise as most economist predicted, they dropped significantly.
It goes to show that the direction of interest rates is anyone’s guess. Investors who listened to these forecasts and trimmed the duration on their portfolios missed a significant bond rally. Many investors underweighted bonds coming into 2019 and they missed out on a large rally in the asset class.
The directions of short term interest rates, which are largely guided by Fed Funds policy can also be unpredictable. At the end of 2018, most economists forecasted that the Fed Funds rate would either be the same or higher one year from that time but just last week we saw the first interest rate cut in over a decade.
While bond investors should always be aware of the possibility that interest rates could rise, there is no reason to panic or make any drastic moves based on someone’s forecast. Investors should instead maintain a reasonable allocation to high quality bonds and ignore most of the interest rate forecasting noise.
These mini “panics” in bond markets, or periods of time of selling, can create opportunities for the patient investor in the area of closed end funds. Investors who keep an allocation to bonds may want to take advantage of these opportunities to purchase bonds at discounts, available through the purchase of certain closed end bond funds. Yet again, most investors were wrong, bonds in fact rallied, and purchasing closed end funds in 2018 was a home run for bond investors.