29 September 2020
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When the Fed Talks Inflation, Bond Investors Listen
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Most recently, you mayhave read that Federal Reserve Chair Jerome Powell announced a change in howthe Fed views inflation. In the past, the Fed said it would consider adjustingshort-term rates when inflation approached 2 percent. But in light of 2020’smany challenges, the Fed’s new policy may allow inflation to run above 2 percentfor a period of time before any shift in monetary policy is considered.1 

For many, bonds are acritical component of their overall investment strategy. So any change in Fedpolicy regarding inflation may influence a portfolio. That's why it’s so importantto understand that the market value of a bond will fluctuate with changes ininterest rates. In other words, when interest rates rise, the value of existingbonds will typically fall.2 

There’s no doubt thiswill be a subtle change for many. But for bond investors, the policy shift mayindicate that the Fed has given itself more flexibility in the future. 

But, what does thatmean for the outlook for the bond market as a whole? It’s unclear. However,lower levels of unemployment in recent years have not led to higher inflation.This new phenomenon runs counter to the Phillips curve, a concept which statesthat inflation and unemployment have a stable and inverse relationship. Withthis data in mind and the changes announced by Chairman Powell, it could beargued that the Fed believes the relationship between unemployment andinflation has changed.3 

Keep in mind that if aninvestor sells a bond before maturity, it may be worth more or less than theinitial purchase price. By holding a bond to maturity, an investor will receivethe interest payments due plus your original principal, barring default by theissuer. Investments seeking to achieve higher yields also involve a higherdegree of risk. 

  

Citations.

1. Schwab.com, August 27, 2020

2. Asset allocation is an approach to help manageinvestment risk. Asset allocation does not guarantee against investment loss.

3. Investopedia.com,May 19, 2019

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