The Risk of Rising Interest Rates

Market Notebook_131231_The Risk of Rising Interest RatesWith 2013 coming to a close, many are asking what is in store for markets in 2014. At Balentine, we believe one big area of risk in 2014 is if interest rates go up by more than they are currently anticipated to do.

Earlier this month, in one of his last moves as Federal Reserve Chairman, Ben Bernanke announced a $10 billion a month taper. Expectations were for a quicker taper, so the stock market reacted favorably, reaching new highs, as opposed to the “taper tantrum” we saw during the summer. Another reason why markets took the announcement in their stride is that the Fed also promised to keep short-term interest rates lower for longer, even if unemployment goes below 6.5% – a number previously cited as a catalyst for raising interest rates. As a result of this, consensus now has short-term interest rates remaining at 0% well into 2016.

In other words, instead of tapping the brakes, the Federal Reserve is slowly taking its foot off the accelerator in terms of monetary stimulus. Over the course of the next year or so, tapering will be complete provided the economy continues to improve at the current pace. The Federal Reserve will then finally begin to tap the brakes.

However, there is always a concern of whether or not the Federal Reserve can orchestrate such a smooth, perfectly timed exit. As Adrian Cronje, Balentine’s Chief Investment Officer, told the Atlanta Journal-Constitution, “There’s only so much [the Federal Reserve] can control. It only takes one piece of bad luck.” If the Fed isn’t able to engineer the exit as planned or if there is a loss of confidence, there is a risk that long-term interest rates can spike up.

For a long time, fixed income has been a very easy go-to for investors looking for “risk-free returns”. The Federal Reserve has robbed investors of that by driving interest rates so low across the maturity spectrum. As a result of our concern on potential interest rate risk, we believe investors should be wary of fixed income providing the traditional, shock-absorbing role that it has typically played in portfolios.

For more on our long-term projections for Safe assets and other building blocks, be sure to download our 2014 Capital Markets Forecast, available in January.

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