With the positive job reports coming out in October, the possibility of the Federal Reserve raising rates in December seems more likely than not. The question remains, how is an investor supposed to react to the impending rise of the Feds Fund Rate? The first step is to understand that the biggest impact is not actually on rates themselves. The chart below is the 10-year Treasury rate over the last year. Over the 1 year time period, the rate is virtually unchanged and bond prices have remained fairly stable, avoiding the impending sell-off that the fear-sellers assumed must happen.
10-Year Treasury Rate
Source: “U.S. 10 Year Treasury.” CNBC. 2015. http://data.cnbc.com/quotes/US10Y.
Compare that to what the US Dollar has done versus a basket of other currencies. When it first became clear that the Fed was discussing rates, the dollar rallied over 10% during this same time period. This is another strong reminder that sometimes what seems like an easy correlation to understand is often much more complex when combined with the incredible amount of variables in the world’s economy.
US Dollar Currency Index
Source: "U.S. Dollar Currency Index." CNBC. 2015. http://data.cnbc.com/quotes/.DXY.
So what does this mean for your portfolio? Be careful to not overreact to a rate increase on your bond portfolio. It is a headwind, but the overall economy is a much more powerful force on long-term rates than the Fed is. Be cautious of precious metals; Gold has already fallen about 10% during the last year and a strengthening dollar can be a headwind unless inflation begins to pick up. Keep an eye on your currency exposure on your stocks but especially your international bonds, currency fluctuations can dwarf the yield of your foreign bonds if you let the exposures get out of hand.