Fed Raises Rates and Announces Balance Sheet Reduction Plans
Sources: Equity Market and Fixed Income returns are from JP Morgan as of 06/16/17. Rates and Economic Calendar Data from Bloomberg as of 06/19/17.
U.S. Stocks finished mixed last week as the S&P 500 Index gained 0.1%, the NASDAQ lost 0.9%, and the Dow Jones Industrial Average moved 0.6% higher. Midcap stocks were the best performing domestic group by market capitalization with a 0.4% gain, while Small cap stocks, as measured by the Russell 2000 Index, fell by 1%. In terms of international stock market performance, developed markets ended the week flat while emerging markets gave back 1.4%. In terms of year-to-date performance so far in 2017, international stocks continue to overshadow the U.S. with developed markets up 14.7% and emerging markets up 17.3%. The S&P 500 index by comparison is up by a still impressive 9.7% since the start of the year.
The Federal Reserve Open Market Committee (FOMC) did in fact raise interest rates last Wednesday by the widely expected margin of 0.25%. This was done in the face of three consecutive months of lower than expected inflation, a condition Chair Yellen acknowledged, suggesting it was likely to be a temporary decline that will revert back to more normal levels during the months ahead. In addition to the rate hike announcement, the FOMC also provided some details on their plans to reduce the size of their nearly $4.5 trillion balance sheet. When the committee deems appropriate (likely later this year), based on financial conditions, they will partially cease the reinvestment of principal of maturing Treasuries and Mortgage Back Securities. Once implemented, the plan would reduce reinvestment by $10B a month for three months and then accelerate that figure quarterly to a maximum of $50B per month. This process will continue until the committee judges the size of their balance sheet to be adequate to conduct monetary policy effectively.
The Fed has now raised rates twice in 2017 and three times in the past 7 months, each time by a quarter of 1%. An interesting observation to take note of is that while the Federal Funds Target Rate was increased 0.75% over this time period, the yield on the 10 year U.S. Treasury fell from 2.54% on December 14 to 2.16% as of Friday, June 16. This highlights an often overlooked point that not all borrowing rates move in tandem. A higher Fed Funds rates does not necessarily translate to higher yields on different types of bonds. Economic growth is likely to continue and will justify marginally higher short term interest rates. However, absent meaningfully higher inflation, it is unlikely that rates will return to historically normal levels during the medium term. If you would like to learn about how Hennion & Walsh is advising clients in this interest rate environment, or if you would like to have a comprehensive portfolio review completed, please do not hesitate to speak with your Hennion & Walsh Financial Advisor or a member of the Hennion & Walsh Asset Management Team.
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Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
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MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITSs that primarily own and operate income-producing real estate.