Some Investors Can't Wait for The Fed to Raise Rates

By Corrie Driebusch 

        Steve Raatz is one investor rooting for the Federal Reserve to push up interest rates.
        Mr. Raatz, 59, said he and his wife are at the stage of their lives where they're trying to avoid the extreme ups and downs that can come with owning stocks. Like many people nearing retirement, the couple, who live in Dallas, would rather put more money in steadier investments such as municipal or corporate bonds.
        The problem is, lately he can't find any high-rated bonds that pay a decent return.
        "We're frustrated," said Mr. Raatz. "CDs and Treasurys, we don't even look at those anymore because the rates are so low they're ridiculous."
        The Raatzes are among millions of savers who have seen interest income shrivel, thanks to the near-zero rates the Fed imposed starting in 2008 in order to breathe life into an economy devastated by the financial crisis. The yield on the U.S. Treasury 2-year note is 0.52% and has averaged 0.73% since the beginning of 2008. In contrast, from 1988 through the end of 2007, the average yield on the two-year Treasury note was 5.23%.
        The Federal Reserve's rate-setting committee is meeting this week, and investors widely expect the Fed to hold rates unchanged.
        Only a few months ago, at the start of 2015, yield-starved investors thought they saw a light at the end of the tunnel. The Fed was expected as early as June to starting lifting rates from near zero, where they have been since 2008. Many thought a rate boost by September was likely.
        But recent weak data on U.S. growth and inflation have yet again pushed back expectations for when the Fed will start raising rates.
        Federal-funds futures, used to place bets on the Fed's interest-rate policy, show that investors now don't see a greater-than-even chance the Fed will raise rates until December. A growing number think the Fed may not move until 2016.
        Low rates are an especially acute problem for those who would put money into bank certificates of deposit, which offer higher interest rates than average savings accounts and offer the extra safety of being insured by the FDIC up to $250,000.
        At the end of 2006 the average yield on a one-year CD was 3.8% and the average yield on a five-year CD was 4.1%, according to Bankrate.com. Currently the national average annual percentage yield for a one-year CD is 0.27%; for a five-year CD it is 0.88%, according to Bankrate.com.
        Investors have responded by shifting their money elsewhere. At the end of 2006, CDs held approximately $2.5 trillion, according to the FDIC. At the end of 2014, the figure was approximately $1.7 trillion.
        With rates near zero, Greg Ghodsi, a financial adviser with Raymond James in Tampa, Fla., has had to adjust his money-management strategy. About two-thirds of his clients are in retirement, and the rest are nearing it.
        Ten years ago, he says, for a typical client entering retirement he would have put 70% to 80% of the portfolio in fixed-income investments. Most of that would go into bonds, with some in CDs. He has cut those allocations to 50% to 60% and is buying more dividend-paying stocks.
        Mr. Ghodsi says he is ready for the Fed to raise rates, as it may encourage bond yields to finally move higher. The magic yield he's waiting for: 5% on tax-free bonds. The Barclays Municipal Bond Index is currently yielding 2.1%.
        In the meantime, he has moved the money that his clients do have allocated to bonds into mostly short-term bonds, typically with an average maturity of one to two years. This offers protection if bond yields jump when the Fed starts raising rates for investors who plan to hold bonds to their maturity, as the money will not be locked up for long at a lower rate and could be reinvested at higher yields.
        "The challenge with that is when you go to short-term bonds, you've eliminated a lot of the risk, but you're also eliminating the reward of income," he said.
        In 2013, the market had its first taste in years of what could happen when short-term rates rise. Federal Reserve Chairman Ben Bernanke said he intended to reduce the Fed's pace of bond buying, triggering what has since been dubbed the "taper tantrum." Stocks plummeted nearly 6% in the next several weeks, and the price of bonds tumbled.
        But to Paul Fahrenwald, a financial adviser with Edward Jones in Farmers Branch, Texas, that bond market selloff in was an opportunity. During that time, he says, he was able to buy high-quality municipal bonds with yields of 5% or 5.25%
        He's currently trying to generate more income for clients by buying shares of energy company Kinder Morgan Inc. and other dividend-paying companies.
        For now, inflation remains at anemic levels, which is typically good for investors who have money in bonds. However, with interest rates so low, investors are still losing money on these safe investments.
        "We're in this pickle," said Chad Carlson, director of research at Balasa Dinverno Foltz, a wealth-management firm based in Itasca, Ill., that manages about $3 billion. "You need to get more than 2% return for retirees. Even with inflation lower right now, you're basically treading water."
        (END) Dow Jones Newswires

        April 28, 2015 05:30 ET (09:30 GMT)

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