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Co-Head of Global Fixed Income Strategy Brian Rehling discusses Federal Reserve rate increase expectations for 2017, and whether or not a rising-rate environment may be here to stay.
Last December, the Federal Reserve raised the short-term federal funds rate by a quarter of a percent; this was the only increase last year, and just the second increase in the last ten years.
The Federal Open Market Committee, or the "FOMC", currently projects that there will be three rate hikes in 2017, but our outlook is for just two rate increases this year. Historically, the FOMC has not been very accurate in their projections. Given our expectation that 2017 will bring a continued modest growth and inflation environment, we look for the Fed to err on the side of caution and continue the rate-hike cycle in a very gradual and measured manner.
However, investors should keep an eye on potential key developments that could shape the FOMC in 2017 and beyond-including two open Board of Governors positions and the even more important appointment of the new FOMC Chair to replace Chair Yellen when her term expires in early 2018. We expect a new Chair to be nominated during the summer to allow time for Senate confirmation. The Fed more directly controls short-term rates, while they have less control on longer-maturity rates. We have seen longer-term rates increase significantly since the Republican victory in November, as investors have increased their expectations for future growth and inflation.
In spite of the recent move higher in longer-term rates, we do not think that a sustained rising-rate environment is here to stay, as macro trends support a low-rate environment over the longer term. These trends include: an aging population, significant government debt levels that limit the potential for sustained fiscal spending, and weak productivity gains. We expect bond-market volatility to pick up given the new domestic fiscal uncertainties. As a result, investors may need to become more nimble with their fixed-income positioning.
Many investors are rethinking their fixed-income allocation in the face of the recent market sell-off. We would remind investors that while volatility is likely to pick up, bonds generally remain a far more stable asset class than equities based on longer-term, historical trends. Investors should keep their focus on their investment goals, and fixed-income investments often play a role. Even during periods of weakness, fixed income can add favorable attributes to your portfolio, including diversification, liquidity, income opportunities, and the potential to reduce the overall volatility of your portfolio.
All investing involves risk including the possible loss of principal. Bonds are subject to market, interest rate, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.
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