One of the most significant challenges facing investors is changing economic conditions that can affect different investors in different ways. This was never more evident than in 2022 when rapidly accelerating inflation forced the Federal Open Market Committee (FOMC), the policymaking body of the Federal Reserve, to raise interest rates seven times - which was more than ever before in a one-year period. This action by the FOMC was taken in an effort to curb 41-year high inflation in June 2022 of 9.1%. By the end of 2022, the FOMC had increased the federal funds rate (a very short-term interest rate) by 4.25%. To some investors, this came as very good news, and disastrous news to others.
As a result of the rapidly rising federal funds rate, the Treasury yield curve inverted in July 2022 – which means that the yield on the 2-year Treasury Bill exceeded the yield of the 10-year Treasury. While an inverted Treasury yield curve is often considered a predictor of a potential economic downturn to come, it produced an interest rate environment that substantially benefited conservative investors. Since an inverted Treasury yield curve provides the highest yields at the shortest end of curve, conservative investors could earn in excess of 5% from 3- and 6-month Treasuries for quite some time. What’s more, short-term Treasuries are considered the risk-free asset since both principal and interest/yield is guaranteed by the U.S. government. For many, it seemed like the perfect, conservative investment.
As noted, this lasted for quite some time. But in September 2024, the Federal Reserve policy pivoted and cut interest rates by 0.5% (or 50 basis points). Two more rate cuts followed later that year in November and December, which is when the Treasury yield curve began to normalize, meaning that longer-term rates began to exceed short-term rates. As a result, Treasury yields began to decline from over 5% to around 3.6% as of early February 2026, and the previously “perfect investment” began to lose its luster.
So, what does the conservative investor do when Treasury (and certificates of deposit) yields drop to a level that is no longer attractive? Let’s look at some areas of the investment markets that typically benefit from declining interest rates.
Bonds - Bond prices and interest rates have an inverse relationship, so as interest rates fall, bond prices rise. When interest rates are falling, bonds with longer duration tend to do better. Duration measures a bond’s sensitivity to changing interest rates – the longer the duration, the more a bond’s price will react to changing rates. High-yield (non-investment grade) may also become appealing for investors seeking higher returns.
CDs and Treasury Bills - As interest rates fall, it may be beneficial to lock in current yields with longer-term CDs or Treasuries. This will protect cash from falling yields in the future.
Growth Stocks - While growth stocks are typically not considered a conservative investment, lower borrowing costs can help improve a company’s profitability and its stock price. Also, technology stocks, for example, are valued at the present value of their expected future earnings. Lower interest rates, referred to here as the discount rate, will equate to a higher present value of the stock.
Dividend-Paying Stocks - These stocks are typically considered a lower-risk stock category. Companies with a consistent track record of paying dividends may become more attractive as a source of income. This benefit may also be compounded by improving stock prices.
Cyclical Stocks - These stocks tend to perform better as the economy responds to lower interest rates. These asset categories include consumer discretionary, financials, and industrials, and are often found in value mutual funds or exchange traded funds (ETFs).
Real Assets - Changing economic conditions can often create uncertainty. Commodities such as gold and silver can act as a hedge against this uncertainty and have produced very impressive returns over the last two years. Metals can be owned in physical form, but can be a challenge with transporting, storage, and insuring. There are mutual funds and ETFs that provide for much easier ownership free of the challenges noted above.
Changing economic conditions often create challenges for investors but may also create attractive opportunities. While always keeping in mind the investor’s risk tolerance, pursuing investments that tend to perform better in the expected future economic environment may help the investor maintain the rates of return they may need for maintaining, for example, retirement income. Regular monitoring and occasional portfolio rebalancing may also help in achieving desired outcomes.
Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.