FLASH REPORT: Global Fixed Income –
Strategies for a Rising Rate Environment
January 2011
 ising interest rates. The question is when, not
if, rates will rise. The entire yield curve remains
artificially low, a combination of skittish investors and
government intervention in the bond markets.
Some facts about rising rates. When interest
rates increase, they tend to do so sharply. Chart 1 shows
that movements in yield on the 10-year Treasury bond
can be violent in either direction. We have not had
a sustained rally in rates (and therefore a sustained
decline in bond prices) since the 1970s. Therefore,
it is difficult to know precisely how financial assets,
both equities and fixed income, will react in such
an environment. But we can make some reasonable
inferences based on the interest rate increases we
have experienced during the more recent past.
Table 2 highlights the performance of several segments
of the fixed income markets during periods of
rising interest rates1. Nothing here is particularly new
or surprising. Rising interest rates are more impactful
on longer duration bonds. Shorter term bonds perform
better during rising rate environments, though
they may not necessarily have positive returns. To the
extent that rising rates are associated with a stronger
economic environment, credit sensitive bonds tend
to outperform government bonds. For credit sensitive
bonds, especially high yield, their higher coupon payment
moves current cash flow earlier, thereby reducing
duration and interest rate sensitivity.
The intersection of short duration and credit
sensitivity are traded bank loans, often referred to as“senior secured loans,” as they represent a superior
claim in bankruptcy to general corporate and other
unsecured debt. These securities are floating rate,
where interest varies with common benchmark rates
such as LIBOR or the Prime Rate.
Treasury Inflation-Protected Securities (TIPS) are
often assumed to provide protection in a rising rate environment. However, this is not necessarily so. Inflation
is defined by the Consumer Price Index (CPI),
which also includes adjustments for real estate and
improvement in product quality. It is possible to have
rising interest rates but still see only modest gains in
the CPI, and therefore only modest adjustments in
TIPS pricing.
Given the somewhat volatile nature of all fixed
income markets during a rising rate environment,
not all of these strategies may be appropriate, or they
may not necessarily be appropriate at all points in
the cycle. Newgate’s Global Fixed Income Portfolio
allocates strategically across these and other segments
of the fixed income markets. While there is risk in
all segments of the market, ironically in a rising rate
environment, it is the “safest” – government bonds –
that may in fact have the most to lose.
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