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Fed Watch 2016: Schwab's Perspective on Rates

Where Will the Fed Go from Here?

As Federal Reserve policymakers get ready to meet later this week, it looks like a rate hike may be on hold once again. Market expectations for an increase in the federal funds target rate in June have been reduced to almost nil following a disappointing May employment report, and are less than 20% for the Fed’s July meeting, based on the federal funds futures market. In fact, you have to go all the way to this coming December to see a greater-than-50% chance of another hike.

The Fed’s post-meeting statement may leave the door open to a rate hike in July, but given weak global economic growth, low or even negative interest rates abroad, and recent signs of weakness in the U.S. job market, it’s unclear when the Fed will raise rates again. 

What’s holding the Fed back?

A disappointing May employment report doused expectations of a rate increase at this week’s meeting. While individual monthly employment reports can be volatile, there also have been some longer-term signs of a softening job market. The Fed’s Labor Market Conditions Index has been falling since December, and now stands at its lowest level since 2009.

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“There have been dips that low in the index that subsequently corrected to the upside, but far more often readings that low have been seen during recessionary periods,” says Kathy Jones, senior vice president and chief fixed income strategist for the Schwab Center for Financial Research. “This Fed has been cautious in its approach to tightening policy, and the recent data will probably warrant ongoing caution.”

Ultra-low and even negative rates in countries outside the U.S. will also likely stay the Fed’s hand. “If the Fed moves rates up too quickly, the dollar could rally, resulting in slower exports and falling import prices,” says Kathy.

What to watch at the Fed meeting

Even if the Fed leaves rates unchanged in June, there will be other information to scrutinize from the meeting. This is one of four meetings each year in which the Fed shares its projections for interest rates over the next couple of years. Kathy expects the median projection will remain at two rate hikes this year, although there is a chance it will slip to one in light of recent disappointing conditions.

It also wouldn’t be surprising to see the Fed lower its estimate of what it considers “full employment” to 4.5% from the current level of 4.8%.  Such a change would suggest there is room to delay further hikes to allow for more slack in the labor market to be absorbed.

The markets will also be watching for any time reference in the Fed’s statement about the next rate hike.  In a recent speech, Fed Chair Janet Yellen made no mention of a rate hike “in the next few months,” which could be a signal that the Fed is back in wait-and-see mode. “If it re-enters the language of the statement, that could be a surprise and put a July rate hike back in play,” says Kathy.

Bond investors should be careful

Yields in the U.S. and much of the rest of the world remain extraordinarily low, but investors should be careful about chasing higher yield. “The longer and deeper low or negative rates go, the more it pays to be cautious about chasing yield in any direction,” warns Kathy. She says investors should make sure they are well diversified and not overly exposed to riskier parts of the fixed income market that could be more vulnerable to a weaker economy. Investors may also want to consider rebalancing parts their portfolios, given how much some bonds have appreciated.

What you can do next

  • Talk to us about your fixed income portfolio. Call a Schwab Fixed Income Specialist at 877-566-7982.
  • Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.
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Important Disclosures

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or geopolitical conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.   Supporting documentation for any claims or statistical information is available upon request.

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

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.

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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