At the end of 2018, the interest rate on a 10-Year Treasury bond was 2.7%. The belief among professionals at this time was that interest rates would rise in 2019.1 These economists believed Trump’s tax cuts and continued economic momentum would ignite growth and inflation, thus higher interest rates. Very few of these professionals forecasted rates would be lower at this point. 2
In fact, according to the Wall Street Journal poll, none of the 69 economists in a study conducted in January predicted the 10-year Treasury bond would drop below 2.5% by June.3
The Philadelphia Fed’s survey of professional forecasters, a poll of roughly 40 leading economists, predicted interest rates would be 2.9% by June 30th. These economists all come from impressive backgrounds from major Wall Street banks and prestigious academic institutions, and are among the most recognized source for economic forecasts.4
How did they do? The actual yield on a 10-year Treasury bond as of the end of June was 2.0%5. So 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. In fact, the total return on a 10-year Treasury bond (a barometer for the entire bond market) for the first half of 2019 is 7.6%5!
The directions of short term interest rates, which are largely guided by Fed Funds policy, also are unpredictable. At the end of 2018, Bloomberg was forecasting an 87% chance that the Fed Funds rate would either be the same or higher one year from then. However, now, the implied probability of a rate cut is 100%.6
While bond investors should always be aware of the possibility that interest 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.
Also, investors might want to consider a bottom-up approach to investing in bonds. This implies not trying to target specific portfolio duration, but rather building a portfolio of the most undervalued securities available. When nearly every economist is forecasting higher rates, as they were at the end of 2018, patient bond investors may find opportunities to buy high quality bonds at discount prices.
1 Reuters June 13, 2018
3 WSJ, June 20, 2019, “10-Year Treasury Yield Falls Below 2%, Defying Expectations”
4 Federal Reserve Bank of Philadelphia
5 Bloomberg Analytics
6 Bloomberg Analytics