KATHY JONES: Recently Federal Reserve Chairman Powell indicated that he thought the markets are pretty well prepared for further Fed rate increases, and he didn’t seem too concerned about the recent pickup in volatility, and yet we have seen volatility stay high and actually accelerate in the past couple of weeks. So, should investors be concerned about more rate hikes from the Fed as the year goes on?
I’m Kathy Jones, and this is Bond Market Today. With me today is my colleague Collin Martin, and we’re going to discuss Fed policy and what impact that might potentially have on the markets going forward.
So, Collin, what was your takeaway from the last Fed meeting?
COLLIN MARTIN: Well, even though there was no action at the recent Fed meeting, our takeaway is that the Fed’s likely to continue raising rates going forward, so the Fed maintained its benchmark interest rate range in the 1-1/2 to 1-3/4% range. What we were looking for was how they would address the recent rise in inflation. You know, inflation’s been trending up this year, and now three of the four main inflation indicators are at or above the Fed’s 2% target--but based on what we saw on the statement, the Fed didn’t seem too concerned with that. It seems like the Fed’s okay with inflation being a little bit above that 2% target for the near-term.
So, all that being said, we do think the Fed will hike again at the June meeting. We think we’ll see at least two more hikes this year, but what we’ll be looking at is the trend in inflation. So, if it moves appreciably higher, you know, significantly higher than where it is now and well above the Fed’s 2% target, that could allow them to increase the pace of their rate hikes.
But now what the Fed does, it doesn’t just have an impact here domestically… it has impacts globally, on global bond yields, on currencies, so can you give us an overview of what’s happening there?
KATHY: Sure--and, in fact, I think the reaction has been greater outside the United States than in the domestic market. So one thing that’s happened is the dollar’s picked up, it’s rallied about 6% on a trade-weighted basis in just the last month or so, and that’s a pretty sharp acceleration in a short period of time, and that has had an impact, particularly on emerging market bonds and currency. So what we’ve seen there is pretty sharp declines in both the currencies and in the bond prices. Yields have shot up, and interestingly, not only in the local currency emerging market bonds, but also in the U.S. dollar-denominated bonds, and that typically happens when the Fed hikes rates. Historically, tightening policy on the part of the Fed reduces global liquidity, and then that tends to make emerging market bonds underperform other bonds. And that’s one reason we’ve suggested over the past six months or so to underweight emerging market bonds, because history tells us that this is not usually a good indicator for that part of the market.
But if investors are concerned, what should they do about rising volatility? What are some steps they can take?
COLLIN: Well, if you are concerned about rising volatility you can consider short-term, high-quality, fixed-income investments. They tend to be great diversifiers for a broad portfolio. They tend to be uncorrelated with U.S. stocks, so stocks are moving one way, you know, the prices of short-term, high-quality, fixed-income investments might be moving the other way.
But also, as the Fed’s been hiking rates, you can get higher yields today. You can get higher yields without taking as much interest rate risk, or as much credit risk, as you’ve had to over the past few years. I think a great example is just looking at the short-term treasury yields. You can get around a 2.2% yield on a one-year treasury bill. Just a year ago you would have had to go out seven years in maturity, which, you know, increases the interest rate risk in your portfolio if you’re taking on that much duration. So, you can get higher yields today without taking too much risk, and it can help limit the overall volatility of your portfolio.
KATHY: That’s a great suggestion. If you’d like to learn more about the bond market or investing in fixed income, you can find us on the Insights & Ideas tab at Schwab.com, or you can follow me on Twitter @KathyJones.
Thanks for watching.