Weekly market & economic update
Federal Reserve rate increases are consistent with our view of a strong U.S. economy
June 14, 2018
The Federal Reserve (Fed) has announced an increase of 0.25 percent in the benchmark funds rate, which moved the rate to 2 percent. Median estimates by Federal Open Market Committee (FOMC) members for 2018 rate hikes have moved higher and now indicate a total of four rate hikes this calendar year. This still leaves interest rates at half the level they were prior to the global financial crisis (5.25 percent in September 2007). Meanwhile, markets are currently pricing in only 50 percent odds of a fourth hike in 2018, with an additional 1.75 hikes (one hike with 75 percent odds of a second one) in 2019.
Fed rate increases and rising inflation may push bond yields higher
After the rate announcement, bond yields initially rose, with the yield increase favoring shorter-term bonds — a sign we believe indicates investor concern for long-term economic growth prospects. We expect bond yields to rise modestly this year, supported by continued gradual removal of central bank accommodation, stable growth, rising inflation expectations and higher U.S. Treasury supply.
Our view remains that the Fed is likely to increase rates a minimum of three times this year, with a material and rising possibility of a fourth hike. A fourth rate increase ultimately depends on the continuation of strong economic growth, as well as firming inflation, during the back half of the year.
Balance portfolio risk exposure in an effort to manage asset volatility
While Fed rate hikes may eventually temper economic growth, we believe the trend remains positive for both growth and inflation. In portfolios, we see risks as more balanced for stocks relative to bonds. We extend this assessment to the fixed income market, as well, and are becoming more cautious in our view of corporate bonds. Safe-haven bond yields now provide meaningful competition versus other riskier assets. In the current environment, shorter-term bonds are likely to provide most of the yield relative to longer-term bonds, with materially less price sensitivity to rising rates.
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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results.
Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.