11+ Trading Strategies in Rising Interest Rate Environments

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Written By
Contributor Image
Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.

In rising interest rate markets, traditional trading and investment strategies may not perform as expected due to the inverse relationship between interest rates and bond prices, along with the potential for decreased consumer spending and increased costs for borrowing companies.

We look at several strategies investors and traders might consider to potentially benefit or protect their portfolios in such an environment.


Key Takeaways – Trading Strategies in Rising Interest Rate Environments

  • Short Duration Bonds
  • Enhanced Cash Strategies
    • Ultra-Short Bond Funds
    • Cash Management Strategies
  • Floating Rate Notes (FRNs)
  • Bank Loans and High-Yield Bonds
  • Multi-Asset Diversification
  • Defensive Stock Sectors
  • Inflation-Protected Securities
  • Commodities and Real Assets
  • Dividend Growth Stocks
  • Tactical Asset Allocation
    • Global Bond Strategies
    • Tactical Shifts in Duration
    • Liquid Alternatives
  • Hedging Strategies
  • Technology and Innovation


Short Duration Bonds

Focusing on bonds with shorter maturities (e.g., 5 years or under) can help minimize interest rate risk.

Shorter-duration bonds are less sensitive to changes in interest rates compared to longer-duration bonds.

As rates rise, the prices of existing bonds (especially those with longer maturities) tend to fall.


Enhanced Cash Strategies

  • Ultra-Short Bond Funds – Investments in ultra-short bonds, which have maturities typically less than one year, can offer higher yields than money market funds with slightly more risk but significantly less interest rate sensitivity than longer-duration bonds.
  • Cash Management Strategies – Leveraging treasury management solutions or investing in higher-yielding money market instruments can optimize the return on cash positions without significantly increasing risk.

Just be sure to understand what your trade-offs are with the various options.

Some, for example:

  • require lockup periods (e.g., some certificate of deposit (CD) or I Bond investments)
  • have variable rates
  • have minimum or maximum investment limits
  • have fees


Floating Rate Notes (FRNs)

Floating rate notes have interest payments that reset periodically based on a reference interest rate (e.g., SOFR).

This feature can make FRNs more resilient to rising interest rates compared to fixed-rate bonds.


Bank Loans and High-Yield Bonds

Securities like leveraged loans or high-yield bonds can be more resistant to interest rate rises, partly because they often come with higher yields that can offset interest rate risks.

Here, a lot of the yield is due to credit risk rather than duration risk.

Nonetheless, in rising rate environments, credit risk can also be exacerbated if less credit creation in an economy causes earnings and cash flow to fall.


Multi-Asset Diversification

Incorporating a mix of asset classes, including those not directly correlated with bond markets like certain types of alternative investments, can reduce the overall portfolio’s sensitivity to rising rates.

Related: Balanced Beta


Defensive Stock Sectors

In equities, certain sectors tend to be more resilient or even benefit from rising interest rates.

These include financials, as banks and financial institutions can earn more from their lending activities, and sectors less sensitive to economic cycles, such as consumer staples, healthcare, and utilities.


Inflation-Protected Securities

Inflation-linked bonds (ILBs) such as Treasury Inflation-Protected Securities (TIPS) in the US, and similar instruments in other countries (e.g., GILTs in the UK), adjust their principal value based on inflation rates.

These can be more attractive in environments where interest rates are rising in response to inflation pressures.

ILBs may not have the same rate sensitivity as their nominal bond counterparts, but they still have interest rate risk that will affect their prices.

So, in a rising interest rate environment, ILBs may still lose value even with their principal adjustments.

This makes them a fairly confusing asset class to many who think they’re getting something closer to a pure inflation hedge. (They’re not inflation swaps.)


Commodities and Real Assets

Investing in commodities or real assets (like real estate or infrastructure) can offer a hedge against inflation, which often accompanies or triggers rising interest rates.

Commodities, in particular, can benefit from higher inflation rates.


Dividend Growth Stocks

Companies with a history of consistent dividend growth can be more resilient in the face of rising interest rates, especially if they operate in sectors less affected by borrowing costs.


Tactical Asset Allocation

Adopting a more dynamic approach to asset allocation can help manage risks associated with rising rates.

This may involve adjusting the portfolio’s exposure to various asset classes based on the current interest rate outlook and market conditions.

For example:

  • Global Bond Strategies – Active management of bond portfolios, including the use of global bonds and currency strategies, can navigate different interest rate environments across countries.
  • Tactical Shifts in Duration – Actively shortening the duration of bond investments or shifting towards bonds with floating rate notes can reduce the portfolio’s interest rate risk.
  • Liquid AlternativesLiquid alts are strategies that provide access to alternative asset classes with the liquidity of traditional securities. They offer a potential hedge against market volatility and rising interest rates depending on how they’re constructed.

That said, tactical asset allocation strategies aren’t easy to pull off (they’re difficult even for professional traders/investors) and aren’t passive.


Hedging Strategies

Using derivatives, such as futures, options, or swaps, can provide a way to hedge against interest rate risks.

Interest rate derivatives as a hedge can lock in current rates, and reduce/eliminate the impact of rising interest rates on the cost of borrowing and investments.

For example, using interest rate futures or options to hedge bond portfolios.


Technology and Innovation

Exploring new financial instruments and platforms that are less interest rate sensitive.


FAQs – Trading Strategies in Rising Interest Rate Markets

How can investors leverage sector rotation strategies in a rising interest rate environment?

In a rising interest rate environment, traders/investors can use sector rotation strategies by shifting their investments/trades/positions towards sectors traditionally seen as beneficiaries of higher rates.

Financials, for example, tend to perform well because banks and insurance companies can earn more from their interest income activities as the spread between their lending and borrowing rates widens.

Another sector to consider is energy, as rising interest rates often coincide with periods of economic expansion and increased demand for energy.

Conversely, sectors like real estate and utilities, which are more sensitive to rising borrowing costs, might be underweighted in portfolios (though it depends because their cash flow might offset the rise in interest rates).

How can convertible bonds be used as a strategy in rising interest rate markets?

Convertible bonds offer a unique way to reduce interest rate risk while maintaining exposure to potential equity upside.

These bonds can be converted into a predetermined number of the issuer’s shares, typically at the bondholder’s option.

In a rising interest rate environment, if equity markets perform well, the equity-like feature of convertibles allows investors to participate in stock gains (potentially offsetting the negative impact of rising rates on the bond component).

However, if stock prices fall, the bond acts as a downside protection with its fixed income characteristics.

This dual nature makes convertibles an attractive option for those who want protection from the vagaries of interest rates.

How do Real Estate Investment Trusts (REITs) typically respond to rising interest rates, and what strategies can be employed?

REITs often face headwinds in rising interest rate environments as their high yield becomes less attractive relative to safer assets like Treasury securities, and their borrowing costs can increase.

But not all REITs are equally affected.

Those focusing on sectors with short lease durations (e.g., hotels or some forms of retail) can adjust rents more quickly to inflationary pressures, potentially mitigating the impact of rising rates.

Additionally, REITs operating in sectors with strong demand fundamentals, such as data centers or logistics, may also fare better.

Investors might consider selectively investing in these types of REITs or looking for REITs with strong balance sheets and the ability to cover interest expenses comfortably.

How do gold and other precious metals perform in a portfolio during periods of rising interest rates?

Gold and other precious metals are often considered as hedges against inflation – in the long-run – rather than direct hedges against rising interest rates.

Gold’s price action is more of a function of real (inflation-adjusted) interest rates than inflation or changes in nominal interest rates.

Namely, gold tends to rise when real rates fall and vice versa.

Silver is more mixed because it’s an even less liquid market where around half the market is used in industrial production, which gives it a greater correlation to global credit cycles.

Their performance in environments of increasing rates can be mixed.

While higher interest rates generally increase the opportunity cost of holding non-yielding assets like gold, inflationary periods that often accompany rate hikes can enhance gold’s appeal as a store of value.

Therefore, incorporating a modest allocation to gold or other precious metals can serve as a diversification strategy and inflation hedge within a broader portfolio, especially when real interest rates (interest rates adjusted for inflation) are negative or low.

How do algorithmic trading strategies adjust to rising interest rates?

Algorithmic trading strategies can quickly adapt to changing markets, including rising interest rates, by leveraging vast datasets and sophisticated models to identify and execute trades.

These strategies might include momentum trading, where algorithms buy assets trending upwards and sell those trending downwards, potentially capitalizing on sectors benefiting from higher rates.

Alternatively, mean reversion strategies could be employed to profit from short-term corrections in assets adversely affected by rate hikes.

Furthermore, algorithms can also implement more complex strategies like statistical arbitrage to exploit temporary mispricings between related financial instruments, adjusting portfolios in real-time to manage exposure to interest rate movements.



Each of these strategies comes with its own set of risks and considerations.

The effectiveness of a particular strategy can depend on the speed and magnitude of interest rate changes, the underlying reasons for those changes (e.g., inflationary pressures vs. policy adjustments), and the overall economic context.

These strategies should be tailored to individual profiles and market conditions, considering the broader economic outlook and personal risk tolerance.

In using these strategies, it’s important to consider the broader economic context, such as the pace of rate increases and the overall health of the economy, to tailor approaches effectively.