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What you should know about the Fed’s rate hike

Our Blog Mar 15, 2017
Edward Al-Hussainy, Senior Interest Rate and Currency Analyst

The Fed has concluded its March meeting with an expected announcement to raise rates. Here is what to watch for now.

The Federal Open Market Committee (Fed) announced a raise in its short-term interest rate target by a quarter percentage point, with a target range of 0.75% to 1%. This change was expected as Federal Reserve speakers have clearly communicated their intentions over the past two weeks. In addition, the Fed didn’t suggest it will be increasing the pace of increases over the next few years, and it emphasized its 2% inflation target. This signals it is prepared to remain accommodative despite an acceleration in economic activity and inflation. Although we don’t recommend obsessing about each small move by the Fed, here are four things you can do now:

  1. Monitor the pace of future rate hikes. The market will be focused on the pace of future rate hikes as well as the ultimate resting place for rates (the terminal rate). Remember, the Fed entered 2016 with a median forecast that it would hike rates four times for a total of 1%. In the final meeting of the year, it delivered only one quarter-point hike. In its most recent projections from December, the Fed projected three hikes for 2017, a forecast reaffirmed by Fed Chair Janet Yellen in a recent speech. The Fed publishes and updates the Summary of Economic Projections (SEP), which gives it an opportunity to refresh its expectations for the economy, inflation and the path of rates.
  2. Watch what other countries are doing. The Fed can always be a swing factor to bond pricing, but the risks are much more balanced than the financial press suggests. Economic data and financial conditions have both bounced sufficiently this year to allow the Fed to continue raising rates. But don’t forget the factors over the past years that have tipped the Fed off track and pushed down yields. For one, the Fed’s counterparts in Europe and Japan continue to provide monetary accommodation, making U.S. Treasuries relatively more attractive.
  3. Avoid making portfolio bets on higher rates. While the market will continue to be obsessed with the Fed’s next move, the opportunity to profit from a bet on higher rates is largely behind us. When it comes to market prices, expectations matter.

    “The time to protect a portfolio from falling bond prices is precisely the time that the market believes interest rates will never go up. This is what we saw last summer shortly after the Brexit vote in the U.K. That is no longer the case, because the market is pricing interest rates in line with the Fed’s projected path.” — Gene Tannuzzo, Senior Portfolio Manager

  4. Look out for inflection points. With risk markets priced for perfection and record speculative bets against U.S. Treasuries, bonds may become an attractive and helpful shock absorber in portfolios once again. If a low-growth, low-inflation backdrop reasserts itself, we expect lower rates in the second half of 2017. Investors abandoning bond investments now in favor of cyclical risk exposure should watch for changes in inflation and continued rate hikes, and reconsider.

Bottom line

The Fed’s announcement to raise rates was expected and not particularly surprising. The important thing to do now is watch the pace of future rate hikes, which could be affected by outside factors such as other countries’ monetary policies and inflation expectations.

 

 

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Edward Al-Hussainy

Senior Interest Rate and Currency Analyst