Savers seeking substantial bank and money market interest rates from the Federal Reserve are still waiting.
You could see 0.75% for six months by the second half of 2022, which I agree beats extended zero returns. But US banks have more deposits than they can lend, so they don’t need to rush to raise their savings rates in concert with the Fed’s rate measures.
Bank profit margins, stock prices and shareholder dividends will benefit. CD yields will barely budge.
Do not despair. The picture is brighter for enthusiasts of short-term bond mutual funds and exchange-traded funds (ETFs). Instead of being stuck with treasury bills and puny bank rates, you can join the world of variable rate corporate and real estate debt, taxable municipal bonds, car loan bundles and credit card bills. , revolving lines of credit and, occasionally, soon…maturing junk bonds.
Terms and maturities are only two or three years, but unlike savers, lenders have pricing power here. This suggests that monthly dividends from these funds will rise, pushing yields beyond the current 1% to 1.5% and trending towards 2% and higher.
Which bond funds to buy now
My favorite, FPA New Income Fund (FPNIX), is closed to most new accounts. But there are fine facsimiles, illustrated by Janus Henderson Short Duration Flexible Bond Fund (JASBX, spend rate: 0.64%, return: 0.82%), Thornburg Limited Term Income Fund (THIFX, 0.77%, 1.07%), T. Rowe Price Short Term Income Fund (TSDLX, 0.40%, 1.90%) and USAA Short Term Bond Fund (USSBX, 0.54%, 1.81%).
Load funds may be available without underwriting fees at certain brokerages. Some or all of these funds are better positioned for the coming year than a regular money market account or an ultra-short treasury-focused fund.
Ignore how these and other similar funds lost value in the first weeks of this year. They own the kind of things that benefit from a healthy economy and can withstand Fed rate hikes.
The T. Rowe Price fund holds more than 70% of its portfolio in corporate and securitized assets, such as bundled student loans and auto leases. He also holds short-term IOUs from IHOP and Applebee that currently pay 4.19%, which will be repriced higher as market rates rise. Restaurants are in great shape now that road trips and normal family life have largely resumed.
The USAA fund is more aggressive, holding energy and air credits as well as a handful of short-term loans to Mexican banks. But Mexico isn’t shutting down, and airlines are flying nearly full planes. This is how a fund can keep its duration below 2 (meaning low sensitivity to rising interest rates) but distribute close to 2%.
Opponents will note that in March 2020, many funds like these lost 5% of principal, wiping out three years of performance. But as long as consumers are able to pay their debts in full and on time, and well-known companies are solvent, the risk of loss in the event of default or downgrade is almost nil. And interest rate fluctuations allow fund managers to take advantage of trading opportunities.
That leaves the perils of inflation and rising interest rates. If you’re worried they’ll fly faster and higher than we think – in the spirit of the late 1970s – then steer clear. I’m still in the low rate camp for longer, but not as low as pre-COVID – and that’s good news for savers.