While the Federal Reserve (Fed) still seems to be shying away from raising interest rates at its next meeting in June, calls are coming from many regional Fed leaders to act quicker. James Bullard, president of the Federal Reserve Bank in St. Louis, warned recently of an asset bubble if the central bank did not raise rates soon and Loretta Mester, president of the Cleveland Fed, has been advocating a hike since February.
As I’ve written about before, I agree. It’s time for the Fed to raise rates – employment levels have recovered well, and perhaps fully, and wage pressures are starting to increase. As the Wall Street Journal noted in an April 21 article, major employers such as Wal-Mart are weighing whether to raise prices in order to offset rising wage costs in a tight labor market. “Quit rates are up, and retention rates are down,” Mark Zandi, chief economist at Moody’s Analytics, told the Journal. “That’s when you see wages increasing.”
However, despite the data, I don’t believe the Fed will raise rates any sooner than July/September. What the Fed should do and what it will do are unfortunately two very different things.
Why Hold Cash in a Zero-Rate Environment?
With interest rates set at zero, investors are increasingly wondering whether they should hold cash or cash substitutes such as money market funds. But cash still makes sense for short-term liquidity and also has several benefits for long-term investors:
- Controls overall portfolio volatility
- Manages fixed income allocation’s interest rate and credit risk
- Can be used as “dry powder” to take advantage of new opportunities
- Provides flexibility in making investment decisions
Stay Balanced (With Bonds)
Another way to maintain flexibility and security during this uncertain time is through bonds. At CLS, we believe in bond funds, which includes fixed income Exchange Traded Funds (ETFs). Bonds are more liquid, diversified, and more likely to achieve higher returns at lower volatility over time. By owning a portfolio of individual bonds, an investor can also better manage cash flows. And holding bonds to maturity provides the peace of mind that the principal will be repaid.
In this zero-rate environment, it’s easy to take risks by reaching for too much yield. But as the saying goes, “the yield is always highest before it goes to zero.” So while we wait for the Fed’s decision, now is the time to stay prudent and diversified, to continue to save and stay balanced.
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Fixed Income is an investment style designed to return income on a periodic basis. Generally, fixed income strategies invest in bonds, real estate, loans, and other types of debt instruments. Diversifiable risks associated with fixed income investing include, but are not limited to, opportunity risk, credit risk, reinvestment risk, and call risk. An ETF is a type of investment company whose investment objective is to achieve the same return as a particular index, sector, or basket. To achieve this, an ETF will primarily invest in all of the securities, or a representative sample of the securities, that are included in the selected index, sector, or basket. ETFs are subject to the same risks as an individual stock, as well as additional risks based on the sector the ETF invests in. Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.