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Fed on Pause: Watching and Waiting to Raise Rates

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RANDY: Hello, and welcome to the Schwab Market Snapshot for June 15. I’m Randy Frederick.

Equity and bond markets have been really volatile recently, and part of that volatility is being driven by uncertainty regarding interest rates. So today I’m speaking with Kathy Jones, Schwab’s chief fixed income strategist, to get her perspective on the recent Fed meeting and whether or not a July rate hike is still on the table. Welcome back, Kathy.

KATHY JONES: Thanks for having me, Randy.

RANDY: So, Kathy, as expected, the Fed left interest rates unchanged at the June meeting, and now the Futures Market is telling us that a July hike is very unlikely. So what do you think the Fed is going to have to see in order to get comfortable with the idea of raising rates again?

KATHY: Well, I think they’ve been pretty clear there are three things that they’re watching. They’d like to see economic growth pick up somewhat—it’s been running around 2% in GDP year-over-year. That’s a fairly sluggish pace compared to history, so they’d like to see it a bit stronger.

They’d like to see inflation move up towards their target of 2%. According to the measure that they watch most closely, it’s running below that and has been for several years.

And then, probably most important, they’d like to see the pace of employment growth pick up. It’s faltered here over the last couple of months and that’s a real worry for the Fed and something they cited in their comments as a reason for holding off on a rate hike.

RANDY: Well now, three things that I noticed that came out of the meeting that I thought were kind of important was the Fed updated its projections for GDP, inflation and also short-term rates. So what did these measures tell us?

KATHY: Well, on GDP it tells us that they are still expecting about 2% growth for the next year or so—maybe picking up in the next couple of years. So still a kind of sluggish pace going forward. On inflation they’re looking for that to move up to their target, again, over a period of years.

But the big change was really in the projections on how fast they project that they’re going to raise the Fed funds rate. Coming into the meeting, the median estimate had been for two rate hikes this year. Now that’s still the median estimate, but when you look at the breakdown provided by the various Fed members, six of them now see only one rate hike. That’s six out of 17, so a growing number are anticipating a slower pace.

But then, really, the important thing is when we look out to 2018. They’ve reduced the median estimate for the Fed funds rate from 3% down to 2.4%. So it’s a much slower pace of rate increases than they had been predicting just a few months ago. And it’s much closer to what the market’s been anticipating for quite some time.

RANDY: Well now, I know the Fed would like to go to a tighter policy, but the problem is we have these negative interest rates still proliferating around the world. So what’s your take on negative interest rates, and what impact are they going to have on the Fed’s ability to raise rates in the U.S.?

KATHY: Well, I think it really constrains the Fed from hiking rates very quickly. What we’re seeing is in Europe and in Japan the central banks have actually moved their policy rates into negative territory. And this reflects a slow pace of growth there and there are worries about deflation.

And they’re trying to force money into the financial system to get the economy going and to stimulate growth—and that makes it difficult for the Fed to hike rates. Because obviously if they’re going one direction and the rest of the world is going another direction, that’s going to be a very difficult dynamic in the global economy.

The other impact negative rates have had is that bond yields are now negative in some countries—so all the way out to 10-year maturities. And what effect that has on us is foreign investors tend to bring their money back to the U.S., because we have positive rates. So, again, that holds down our interest rates and it counters what the Fed might be doing in terms of trying to hike short-term rates.

RANDY: Well, that seems like a pretty tough environment all over the place. So what exactly should investors be doing right now?

KATHY: I think one of the important things to keep in mind is that, just because the Fed raises short-term rates, it isn’t necessarily the case that all interest rates will go up by the same degree, or at the same time. The bond market is a big market—it’s very diverse with different types of bonds that react differently to changes in Fed policy. So probably the best thing to do is just keep a very diversified portfolio.

And if you want to learn more about the bond market and get some help, you could check out our new website; we have a new and improved website for fixed income at Schwab.

RANDY: Well, Kathy, we’re about out of time, so thank you very much again for sharing your expertise on these topics. If you want to read more from Kathy, you can get that in the Fixed Income and in the Insights and Ideas section of Schwab.com. You can also follow Kathy on Twitter @KathyJones, and of course you can follow me on Twitter @RandyAFrederick.

We will be back again. Until then, invest wisely, own your tomorrow.

Important Disclosures

Please note that this content was created as of the specific date indicated and reflects the authors’ views as of that date. It will be kept solely for historical purposes, and the authors’ opinions may change, without notice, in reaction to shifting economic, business, and other conditions. The information presented does not consider your particular investment objectives or financial situation (including taxes), and does not make personalized recommendations. Supporting documentation for any claims or statistical information is available upon request.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Schwab Center for Financial Research (“SCFR”) is a division of Charles Schwab & Co., Inc.

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