In the last few years, the fixed income arena has thought the Fed would raise rates fewer times than the Fed projected (blue dots). In contrast, early this year, the bond market began to think the Fed may raise rates more than the Fed projected.
As of this writing, three moves have been fully priced into the Fed Funds Futures market, and the conversation has turned to the possibility of a fourth tightening move in 2018 (one rate hike each quarter). During the aforementioned semiannual Monetary Policy Report testimony, Powell was asked what it would take to raise rates more aggressively than the FOMC’s current projection of three times, and his response was telling:
“We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving up to target,” Powell said. “Each of us is going to be taking the developments since the December meeting into account and writing down our new rate paths as we go into the March meeting.”
While the Fed did not officially change its number of 2018 rate hike projections at this meeting, the issue probably will be revisited, data permitting. Keep in mind that the Fed did tighten four times last year: three rate hikes and a balance sheet normalization announcement at the September FOMC meeting. One could argue that the latter is akin to a rate hike in this still-unusual monetary policy backdrop.
Conclusion
Given the Fed’s guidance and market outlook for additional increases in the Fed Funds Rate in 2018, if not beyond, some “Fed protection” seems warranted. Against this backdrop, we believe that by utilizing a floating rate product, such as the WisdomTree Bloomberg Floating Rate Treasury Fund (USFR), investors may be better able to insulate their bond portfolios as compared to a more traditional fixed income investment.
This article has been republished with permission from Wisdom Tree.