Waiting to finally tell clients that interest rates will rise to respectable levels soon?
Don't get their hopes up, advised Kathy Jones, vice president and fixed income strategist for Charles Schwab's Center for Financial Research.
"Is the groundwork really there [for the Federal Reserve Board] to taper and raise interest rates?" Jones asked during her 2014 Fixed Income Outlook presentation at the annual spring forum of the Financial Planning Association's New York chapter. "The jury is really out."
Schwab is trying to lower its clients' yield expectations, Jones said -- and she recommended that advisors start planning for continued low rates as well. "Rates are not going to be 5% or 6%," she said. "It's going to be more like 4%."
Expectations for higher yields have been commonplace, she acknowledged. But she noted that economists also thought rates would rise last year -- and didn't -- and that the yield on 10-year Treasury bonds has been below 6% for more than a decade.
Economic reality simply hasn't justified the rising rates usually associated with a growing economy, Jones said, noting the painfully slow recovery in the U.S., a weakening economy in Europe and a slowdown in China. In addition, a "deteriorating" crisis in Ukraine is also acting as a potential drag on global economic growth, she noted.
"Historically, the 10-year Treasury yield and nominal gross domestic product growth have always been correlated," Jones said.
The Federal Reserve Board's stated goal of gradually ending quantitative easing and higher interest rates has been "very aggressive," she said. "My guess is that the next set of estimates from the Fed will see rates edge down."
ALTERNATIVES FOR CLIENTS
So what should advisors tell their yield-seeking clients to do?
The classic strategy of "laddering" bond purchases and buying bonds with different average maturities remains highly recommended in the current environment, Jones said: "It's the best way to go."
Schwab is also bullish on investment-grade corporate bonds, she said. "They can be bought individually or in a fund, domestic or international," Jones said. "The risk-reward ratio is favorable."
Clients in high tax brackets shouldn't be afraid of municipal bonds, despite negative publicity about the finances of Detroit and Puerto Rico, she said: "We're big fans of munis, and there's not much default risk."
Advisors should be wary of recommending bonds backed by bank loans and sub-investment-grade bonds, especially those with high yields.
"People are taking too much credit risk and are becoming too complacent," Jones warned.
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