This article was written by Invesco PowerShares Senior Fixed & Equity Income Product Strategist Joseph Becker.
In December, Federal Reserve (Fed) Chair Janet Yellen unofficially established a game time of sorts when she noted that being “patient” meant an interest rate hike is unlikely before April. In response, a majority of economists surveyed by Bloomberg seem to have started a shot clock, interpreting “patient” to mean the first hike will be in the books sometime this summer.1
In late January, noting “solid” expansion of activity and “strong” job gains, the Federal Open Market Committee provided no indication of any change in the timing for a potential summer rate hike. A few days later, St. Louis Fed President James Bullard reiterated his view that “a zero interest rate is not the right rate for this economy.”2
Longer time coming?
But for all the signals pointing toward a summer rate increase, there are opposing indicators, including these:
- Within the contrarian camp, economists at Morgan Stanley recently pushed out their forecast for a rate hike from January 2016 out to March 2016.3
- Since the end of the third quarter of 2014, the projected fed funds rate for January 2016 has trended lower, as shown below, perhaps leading President Bullard to observe that, “The market has a more dovish view of what the Fed is going to do than the Fed itself.”
Lower Projected Fed Funds Rate Signals Market’s More Dovish View
So while the Fed and majority of economists seem to point toward a mid-year rate hike, the market —along with a handful of contrarians — suggests any hike isn’t likely to happen this year.
Implications of rate hike timing
There’s currently plentiful speculation about whether the Fed will raise rates in 2015. But perhaps a more important consideration is what a Fed move would mean, given the changing landscape. A Fed rate hike is, of course, not without broad-reaching implications, but here’s why the long end of the curve may prove a favorable place for investors to be, regardless of what the Fed does.
1. In spite of the fact that the Fed has just entered its seventh year of a 0.25% target rate, the ongoing flattening of the yield curve seems to reflect the bond market’s increasing skepticism about the economy’s ability to grow, as well as the Fed’s ability to influence it. If investors are skeptical to begin with, it’s difficult to see how a growth-restraining rate hike would make investors more optimistic.
President Bullard may have also had January’s flattening curve in mind when he attributed a dovish stance to the market.
Yield Curve Tilted in January to Its Flattest Level Since 2008
Another interpretation might be that investors simply aren’t convinced of the economy’s readiness for a hike, but expect the Fed to pull the trigger anyway. In the absence of an improved growth outlook, if the Fed does raise rates this summer, the long end of the curve may prove to be relatively stable, while the short end may exhibit higher volatility.
2. If the Fed doesn’t raise rates this summer, markets may conclude that the economy isn’t as healthy as the Fed had projected it would be. This, too, could put downward pressure on rates.
Whether or not the Fed raises its target, the road to a steeper curve could prove long and meandering. As the economy traverses it, investors with exposure to longer maturities may be well positioned to benefit from range-bound rates.
Talk with your financial advisor
Investors who expect continued stability at the long end of the curve may wish to talk with their financial advisors about how these PowerShares’ fixed income exchange-traded funds may offer tactical, targeted exposure to longer maturities and higher duration:
PowerShares 1-30 Laddered Treasury Portfolio (PLW)
PowerShares Build America Bond Portfolio (BAB)
PowerShares National AMT-Free Municipal Bond Portfolio (PZA)*
* Within the past 12 months, changes to the Funds’ name and investment objective have occurred. For more information about these changes, please see the Funds’ prospectus.
1 Source: Bloomberg FOMC Survey, conducted Jan. 23-26, 2015
2 Source: Bloomberg News, Jan. 30, 2015
3 Source: Bloomberg News, Jan. 27, 2015
Important information
The Federal Open Market Committee is a 12-member committee of the Federal Reserve Board that meets regularly to set monetary policy, including the interest rates that are charged to banks. Duration is a measure of the sensitivity of the price of a fixed income investment to interest rate changes. The fed funds rate is the overnight interest rate one depository institution charges another for lending funds maintained at the Federal Reserve. A basis point is equal to 0.01%.