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As the Fed lowers interest rates, investors should review their bond portfolio, which could see a boost from the Fed's dovish policy.
The central bank in September began its first easing campaign in four years with a 50 basis point interest rate cut, raising the benchmark interest rate to a range of 4.75% to 5%.
After last week's better-than-expected jobs report, analysts expect future interest rate cuts to be smaller.
However, experts say the shift in Fed policy could be beneficial for parts of the bond market. Typically, bond prices and market interest rates move in opposite directions.
“This is a great time to look at bonds again,” said certified financial planner Scott Ward, senior vice president of composite planning in Birmingham, Alabama.
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In 2022 and 2023, the Federal Reserve issued a series of interest rate increases, sending yields on savings, money market funds, certificates of deposit and other options higher.
Although it may be tempting to hold on to cash, it will become “less attractive and less productive as interest rates fall,” Ward said.
Long-term investors can now “get a much greater return from the safer side of the portfolio” through bonds, he said.
Here are some options to consider, according to financial advisors.
Corporate bonds
In a bearish rate environment, you might consider medium- to long-term corporate bonds, according to Ted Jenkin, founder and CEO of oXYGen Financial in Atlanta.
During the third quarter of 2024, the Morningstar US Corporate Bond Index, which measures investment-grade corporate bonds, returned 5.8%, higher than the overall bond market at 5.2%.
Many companies have taken advantage of ultra-low interest rates during the pandemic to bolster balance sheets and refinance debt, Ward said.
“I think we will see companies come out of this rate hike cycle in very good shape,” he said.
Municipal bonds
As investors brace for potential higher taxes in the future, municipal bonds could become more attractive, especially among residents of high-income states.
Muni bond interest is federally tax deductible and avoids state fees when you live in the issuing state. Muni bonds typically have a lower risk of default than corporate bonds.
“Longer-term municipal bonds should do better if the Fed continues to lower interest rates,” Jenkin, who is also a member of the Council of Financial Advisors, told CNBC.
“Municipalities offer two excellent qualities for long-term investors,” Ward said, including the potential for attractive returns combined with low risk.
Advisers extend the “duration” of bonds
When constructing a bond portfolio, advisors weight duration, which measures the sensitivity of bonds to interest rate changes. Expressed in years, the duration formula includes the bond's coupon, time to maturity, and the yield paid during the term.
Some advisers have begun increasing bond duration ahead of the Fed's first rate cut in September.
Jenkin said his company began shifting to “medium-term” bonds, which he defines as five to 10 years, about four months before the Fed's first rate cut.
As interest rates fall, experts say those bonds with longer maturities should reward investors.
