What a Fed Rate Hike Would Mean for Investors and Savers

This differs from the Consumer Price Index (CPI) figure, which serves as the official inflation rate and is expected to be released on the morning of Sept. 11. Nonetheless, the high PPI figure has sparked concerns in the markets about a potential rate hike by the Federal Reserve on Sept. 16.

This marks a significant shift from earlier this year when rate cuts were anticipated from the Fed. This change has suddenly elevated the importance of the typically unexciting component of your portfolio – bonds.

Following the PPI report on Thursday, the 30-year Treasury yield rose above 5.35%, reaching its highest level in over two decades. The 10-year yield also reached a multi-decade high above 4.95%.

Long-term bond yields reflect investors’ expectations regarding inflation and interest rates in the long run, and at present, investors are adapting to the notion that high inflation and elevated interest rates are here to stay for the foreseeable future.

Shorter-term Treasury yields indicate short-term expectations, such as the Fed’s actions regarding benchmark interest rates at its upcoming meeting. Following the PPI report, the yields on the 3-month, 6-month, and 1-year Treasury bills also experienced an increase, in anticipation of a 25-basis-point hike on the 16th.

One might assume that yields will continue to rise if the Fed proceeds with a rate hike – however, according to Kody Sherlund, a certified financial planner based in New York, we may actually witness the opposite effect on long-term bonds. This is because the expected hike is likely already factored into the market, and a decision to not hike rates is now the unpredictable scenario.

“In the realm of bonds, a rate hike reinforces the Fed’s credibility on inflation and could potentially help stabilize or reduce long-term yields, as it diminishes the inflation risk premium demanded by investors. Conversely, a scenario without a rate hike could pose challenges for equity and bond markets if the Fed is perceived as accepting above-target inflation,” Sherlund explained in an email interview.

We observed this phenomenon in late July when the Fed narrowly opted to maintain rates at current levels. The markets reacted negatively to this, interpreting it as the Fed falling behind in addressing inflation, leading to a surge in long-term yields.

We may witness a similar counterintuitive reaction on the 16th – maintaining rates could cause yields to rise, while a rate hike could cause yields to fall.

A brief Bonds 101 refresher: Bonds provide a fixed amount of principal and interest if held until maturity, but their market value fluctuates over time.

When we mention that a bond’s yield has increased, we are essentially stating that its market value has decreased, as a lower purchase price translates to a higher return on the bond’s payment value in percentage terms.

This implies that purchasing bonds while yields are high (i.e., prices are low) and holding them until maturity allows you to secure that high yield – even if yields decline shortly after.

Considering this, it may be enticing to capitalize on high yields by investing in bonds now – particularly given the possibility of a decrease after the anticipated rate hike. What are the advantages and disadvantages of this approach?

“T-bills provide income that is exempt from state and local taxes, unlike CDs, which are taxed at the federal and state level,” Cheng explained.

She also highlights that T-bills are more liquid than CDs as they do not come with early withdrawal penalties. While they lack FDIC insurance like CDs, they are backed by the full faith and credit of the U.S. government.

Below is a list of the top-rated brokers reviewed by BW that offer Treasury bonds, bills, and notes.