Using US Rate Hikes to Build a Stronger Bond Portfolio
There is something that has raised concern more than the current move by the US Federal Reserve raising rates.
While raising key policy rates by another 25 basis points, the US Federal Reserve said it does not expect to cut rates in 2023.
It means the most powerful central bank in the world will continue to keep raising interest rates in an attempt to control inflation.
The concern is that rising borrowing costs could worsen the ongoing crisis in the US banking sector, which could cause more trouble for more markets around the world.
US Federal Reserve Actions
- Key policy rate raised rate by 25 basis points
- End-2023 median rates estimated at 5.1%
- Sees more tightening of rates as appropriate
- Sees financial turmoil ahead due to tighter credit conditions
- Rules out the possibility of rate cuts in 2023
What does the rate hike mean for India?
Capital Outflow: Higher interest rates in the US could lead to more capital outflows from India as investors choose "safe haven" prospects.
Foreign portfolio investors have already sold over $ 4 billion in stocks in 2023 so far, compared with $16 billion in the whole of 2022.
Impact on stocks: Rising rates are not generally considered as good for stocks as it increases the cost of capital. This will mean companies have to pay higher interest on their loans. Another concern is that it will lead to a fall in overall demand in the economy as disposable income and savings for households fall due to a rise in loan instalments.
Impact on the rupee: A rise in capital outflows could weaken the rupee unless exports rise. The latest data shows India's current account in July-September 2022 was a record deficit of $36.4 billion, significantly higher than the $9.7 billion shortfall in the previous quarter.
However, the finance ministry expects the deficit to fall in the year to March due to a rise in exports of services and a fall in oil prices.
What should fixed-income investors do?
Rate increases give you an opportunity to buy good quality bonds at better yields, as bond prices fall when interest rates rise.
Bond investors can consider a 'laddering up 'approach to their portfolio. In this method, an investor can buy bonds with various maturity dates.
Instead of investing a lump sum into a single bond, you can divide the investment into smaller portions and allocate each portion to a bond with a different maturity date.
This will not only provide a consistent and predictable cash flow but also provide the opportunity to invest unallocated capital in a bond with a higher interest rate.
Always consult your financial advisor before taking an investment decision.
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