Rates still likely to Rise in 2015 but Expect Low Rates for the Foreseeable Future
While Janet Yellen conceded that the projections for future U.S. economic growth and the current state of the U.S. labor market provided for a valid argument that an initial increase to the Federal Funds Target Rate was now warranted, however the Federal Reserve (“Fed”) decided, almost unanimously, that no such action would be taken at this point in time. This somewhat surprising decision has heightened investor uncertainty and will likely lead to more market volatility in the days and weeks ahead. Despite indications from Yellen and the Fed that a September lift off was likely following their meeting in June, based upon their own economic data parameters, the Fed blinked again, in our view, bowing this time to concerns over global economic woes and a weakened inflation outlook in addition to a large contingent of vocal market professionals insisting that it was still too soon for an interest rate hike.
After reviewing the revised projections from the FOMC voting members stemming from the September meeting, we believe that the Fed may be more concerned with future global economic growth potential and its impact on the impish U.S. economic recovery than they are letting on. This is significant and something to watch going forward. For example, after the March meeting, we calculated that the weighted Fed Funds Target Rate of the FOMC voting members for 2016 was roughly 2.0% (2.02% to be exact). Following the September meeting, this weighted Target Rate for 2016 has decreased to roughly 1.5% (1.478% to be exact), with a median projection of 1.4%. Details behind these revised projections can be found in the table below.
Source: Board of Governors of the Federal Reserve System, Fed’s Projection of the Midpoint Target Range or Target Level, September 2015.
In addition, the weighted Fed Funds target rate for 2017 decreased from 3.18% to 2.64% over this same timeframe. Given these downward revisions and current projections from the Fed, it is fair to conclude that while a rate hike in 2015 is still likely (and appropriate from our standpoint), interest rates will remain low for the foreseeable future. We have updated our projected Federal Reserve timeline based upon these outtakes from the September 2015 Federal Reserve Open Market Committee meeting below.
Potential Federal Reserve Action Timeline as of September 2015 (subject to change)
When it does begin to raise interest rates in 2015, we still believe that the Fed will likely follow the blueprint that it utilized during the 2004-2006 tightening period when it gradually raised the Federal Funds Target Rate on 17 different occasions in 25 Basis Point (i.e. 0. 25%) increments over this timeframe. The only difference during this round of tightening that we see is that the Fed may also consider starting to slowly shrink the size of their U.S. Treasuries and Government Agencies securities laden balance sheet, in conjunction with increases to the Federal Funds Target Rate. In other words, instead of just considering raising rates further after each FOMC meeting, they may consider some form of a gradual 1-2 punch of rate increases and sales of U.S. Treasuries (or non-reinvestment of the principal of existing maturing bonds) off of their balance sheet, though not necessarily after each FOMC meeting.
Given that there is as strong of a probability as ever that the Fed will start to raise interest rates in the not too distant future, investors would be wise in our view to consider asset classes or sectors that have historically performed well on a relative basis during previous gradual, drawn-out periods of tightening on the part of the Federal Reserve (see 2004-2006 example above). For example, in terms of Equities sectors, according to Bloomberg, the table below shows the cumulative total return performance of the 10 GICS sectors for the holding period 1/1/2004 through 12/31/2006.
Source: Bloomberg, March 2015. Cumulative total return data provided for the period 1/1/2004 – 12/31/2006. Past performance is not an indication of future results.
Please note: This information is provided for informational purposes only and is not a solicitation to buy or sell any of the asset classes or sectors discussed.