Even though the US economic situation continues to improve, there’s little incentive and even less urgency on the part of the Federal Reserve to enter into a tightening cycle.

Core consumer prices are at a 40-year low and the pace of inflation in producer prices is so moderate that there are few cost increases to be passed along, generating little inflationary pressure. The national unemployment rate also remains uncomfortably elevated at 9.9 percent and critical midterm elections – a period in which no one, not even the supposedly independent Federal Reserve, wants to rock the boat – will be held in a few months.

With high joblessness and little consumer inflation, the odds of a near-term rate increase are low, with futures trading indicating that most investors see only about a 32 percent chance of a hike in the fourth quarter. Most bets are now on the second quarter of 2011.

The upside to the slow Fed response is that investors, many of whom keep sizable bond positions even in unfavorable rate environments to maintain income or for a variety of other reasons, have a chance to shift their bond holdings in ways to mitigate rate risk. There are two main ways to achieve that.

The first is to put your money in the hands of managers who have successfully navigated turbulent rate environments in the past, particularly those who use value approaches that tend to outperform growth-focused bond funds as interest rates begin stepping up.

The ten member team managing Dodge & Cox Income (DODIX) certainly has a lock on this kind of experience, with an average tenure at the firm of 15 years, which means they’ve seen their share of market turbulence.

They use a bottom-up value approach to find their bonds and the collective wisdom of the team had allowed them to build a substantial stake in non-financial corporate bonds over the past two years.

But as prices have rallied they’ve dipped deeper into financial issues and taxable Build America Bonds, two areas of the bond market that still offer a lot of value. They’ve also been adding to their position in mortgage-related securities–primarily agency bonds–which now account for just over 43 percent of assets. Management has been backing off Treasury securities; they think they’re overvalued and some of the most sensitive issues to rate increases.

The team also has been stepping back the fund’s average duration and maturity,  which now stand at 3.9 years and 6.7 years, respectively. Rate risk is obviously a major driver of that decision, but the team is also concerned that the massive monetary and fiscal stimulus still working its way through the system combined with stronger economic fundamentals will soon start to drive inflation.

Dan Fuss has headed Managers Bond (MGFIX) since 1984 and has more than 40 years of experience in the business, generating solid results in both the early 1980’s and in the 2004-2005 tightening cycle (see p. 8 for more information on another of his charges).

Over the past year Fuss has accumulated a better than 7 percent stake in Treasuries and other agency debt as he and his team have sold corporate bonds that have generated substantial capital gains.

Like most fixed-income managers, Fuss believes that we’re in the beginnings of a prolonged upward trend in interest rates that he thinks particularly favors his investment approach.  A value investor, Fuss looks at the debt issued by companies in unloved sectors that have a dominant position, and generate more than enough cash to cover their obligations.

In addition to building up a sizable position in government debt, Fuss also has been shortening the average maturity of the fund. Typically working on a long maturity horizon to reduce reinvestment risk, he’s stepped the average maturity of the fund back to 10.8 years and the average duration to 5.9 years.

Based on past experience, both Dodge & Cox Income and Managers Bond should perform well when the Fed does finally make a move.

The second approach to dealing with rising interest rates is to buy into a fund that’s designed to thrive in just that sort of environment, such as Fidelity Floating Rate High Income (FFRHX).

Christine McConnell, who has helmed the fund since its inception, takes a conservative approach to portfolio management.

Unlike many of her peers who often load up on highly illiquid or poorly rated loans, McConnell focuses places a premium on liquidity and holds many higher-quality loans–the portfolio’s average credit rating is BB.

McConnell also favors debt from large-cap issuers and doesn’t rely on leverage.

The fund invests primarily in loans to asset-heavy companies that carry strong collateral claims, providing ample recourse in the unlikely event a company goes under.

And unlike many managers who delegate the bulk of the research, McConnell insists on scrutinizing and vetting each loan herself.

Bank loans entail a high degree of credit risk and can be extremely volatile. However, McConnell does an excellent job of risk management.

In 2008, a year in which the average bank loan fund lost more than 30 percent, Fidelity Floating Rate High Income gave up only 16.5 percent.

Its beta, a measure of its volatility relative to its benchmark, is only 0.52 relative the S&P/LSTA Leveraged Loan Index and just 0.23 relative to the broader Barclays Capital US Aggregate Bond Index.

But the fund isn’t a pure play on floating-rate bank loans; McConnell devotes about 12 percent of investable assets to short-dated, plain-vanilla bonds that offer high yields. A cash stake amounting to 14 percent of assets is another plus.

Fidelity Floating Rate sports an expense ratio of 0.75 percent, one of the lowest in its category, so McConnell’s expertise comes cheap, and yielding about 3 percent and paying monthly distributions, the fund provides a nice income kick that will come in handy for those depending on steady payouts.