The Federal Reserve met on Wednesday and confirmed that the policy rate forecast for 2024 is unchanged. It is expected that there will be three interest rate cuts in 2024, with the first cut most likely happening in June. The direction of interest rates is probably the single biggest factor that can affect the economy. The Federal Reserve will raise interest rates when they think the economy is strong and inflation is running too high (which we experienced in 2022), and they will decrease interest rates when they believe the economy is struggling and needs some help. Not only do rising interest rates affect the economy because of the extra costs associated (think of your mortgage payment going up when interest rates go up), but changes in interest rates also affect the price of both corporate and government bonds.

 

There is an inverse relationship between interest rates and bond prices. When interest rates go up, bonds go down; and vice versa. The longer the maturity of the bond, the more the bond value moves. The chart below shows the estimated 12-month total return for a bond with a 5% coupon based on a range of interest rate changes along the x-axis. As you can see, if you own a 5-year bond and interest rates fall 0.5% (50 BPS), you will make approximately 7.2% in a 12-month period. If you own a 10-year bond and interest rates fall 1.5% (150 BPS), you will make approximately 17.5% in a 12-month period. This is the reason we spend so much time thinking about the direction of interest rates. Considering that a balanced portfolio will have approximately 40% bonds, these fluctuations can have a big affect on the performance of the portfolio.

 

This is probably a good time to let you know that we've increased the bond duration (maturity length) in our portfolios because we believe interest rates will go down later on this year. We will check back in six months!

 

 

I've also included a piece from our CIBC Economics team entitled "Who needs a bigger dose?”.

 

As always, if you have any questions, please feel free to give us a call at any time.

 

Have a great weekend.

 

Milan