- Inflation remains elevated, meaning the Fed isn’t likely to cut rates soon.
- If inflation stays unchecked, rate hikes might become a possibility down the road.
- Here’s how investing experts are navigating a higher-for-longer interest-rate environment.
Even before the January CPI report showed that inflation was running hot at 3% year over year, Wall Street was already bracing for higher-for-longer interest rates.
The new inflation numbers likely only confirmed the belief of many investors and strategists that rate cuts are off the table until at least September.
“If the Fed cuts interest rates too early, it increases the likelihood that we will see a repeat of the 1970s. The Fed has no other options than to keep interest rates higher for longer,” Torsten Sløk, Apollo’s chief economist, wrote in a recent note. The 1970s were marked by stagflation partly due to the Fed keeping interest rates too low for too long.
While equity investors might wish for lower interest rates, there are certain benefits to a higher-for-longer environment, according to Michael Rosner, managing director and private wealth advisor at Raymond James. Higher rates bring increased opportunities in fixed income.
“For anybody who wants to put money outside of the equity markets, higher for longer is a really good environment for that. High-yield savings accounts, money market accounts, CDs, even high-grade corporate bonds are paying a really attractive rate now,” Rosner told BI. Savers or anyone with cash on the sidelines will benefit from higher interest rates.
Chris Zaccarelli, chief investment of Northlight Asset Management, recommends shorter-duration bonds. That’s because bonds with a shorter duration are less exposed to interest rate risk and also offer attractive yields right now.
“You don’t have to go as far out the curve to 10-year, 20-year, 30-year bonds or Treasurys in order to get higher yields. You can get quite a bit of yield in the shorter part of the yield curve,” Zaccarelli said.
For those that do want to stay in stocks in a high-rate environment, look for quality, Sløk said.
“When interest rates are higher for longer, companies with earnings tend to outperform because companies with earnings are able to pay higher debt servicing costs,” Sløk wrote in a recent note.
Dividend-paying stocks are also a good investment in times like these, according to Rosner. Companies that pay dividends are typically well-established, profitable, and have stable cash flows.
Financials are positioned to do well, too, said Chris Brigati, chief investment officer at investment firm SWBC. That’s because he expects the yield curve to continue steepening as long-term Treasury rates creep higher. Banks borrow at the short-term rate and lend at the long-term rate, and higher interest rates will increase the amount banks earn on loans.
Energy is another sector that’ll benefit from higher rates, both Brigati and Zaccarelli said. Energy and other commodities have historically performed well in higher rate and inflationary environments, according to Zaccarelli.
“If you’re in a business where you’re selling a commodity and you can continue to provide that service or good at a continually higher price and consumers are forced to buy it at any price, then you’re typically more insulated from inflation,” Zaccarelli said.
However, stay away from utilities, Zaccarelli warned, as the sector is inflation-sensitive. Utilities companies are also susceptible to interest-rate risk due to their capital-extensive business models and high debt levels.
Investors can get exposure to these trades through funds like the iShares 1-3 Year Treasury Bond ETF (SHY), the Financial Select Sector SPDR Fund (XLF), the Vanguard Energy ETF (VDE), and the SPDR Portfolio S&P 500 High Dividend ETF (SPYD).
