Donald Trump’s presidential victory upended the status quo, unleashing a host of new U.S. global policy-related questions on top of the macroeconomic challenges already facing global markets.
However, in one regard, Trump’s win didn’t rock the boat too much, and may have reinforced a pre-election prediction—that on December 14, 2016, the Federal Reserve (Fed) is expected to announce an increase in its benchmark overnight rate target by 25 basis points to a new incrementally higher range of 0.50-0.75%.
On Election Day, just prior to vote tabulation, federal funds rate futures priced in an 81% chance of this move, with more increases expected to follow in 2017. Because of market volatility, these odds declined in the immediate wake of Trump’s win, but then rebounded to pre-election levels, as the potentially inflationary implications of Trump’s policies were digested and priced into the bond market.
Fed Rate Hikes and Longer-Term U.S. Interest Rates
American Century’s Global Macro Strategy Team believes the Fed wants to resume normalizing U.S. interest rates—U.S. central bank policy has been abnormally accommodative since 2008. This accommodation helped stabilize the global economy and capital markets, but the resulting historically low interest rates and massive bond purchases punished savers and rewarded risk-taking behavior, increasing the odds of financial market bubbles and other imbalances, including inflation.
The Fed began to normalize interest rates, after an extended period with a 0-0.25% target, with a 25-basis-point increase in December 2015, its first such rate hike since 2006. We think the Fed believes that by increasing interest rates now in small increments at a modest pace, it can avoid bigger, more concentrated moves later that might be more disruptive, and help keep inflation contained.
“We believe the Fed is on ‘inflation watch’ now”
We agree with federal funds rate futures that the odds favor another 25 basis points rate hike this December, assuming that the U.S. economy remains on its present moderate growth path, and that there are no other major data or event surprises or disruptions between now and December 14 (a fragile assumption in today’s world).
With regard to longer-term interest rates, such as the 10-year U.S. Treasury yield, it’s worth noting that they can (and often do) behave independently of Fed moves. Factors such as supply and demand, overseas interest rate levels, economic growth data, and inflation expectations are among the key influences that can sway these yields.
We now believe the 10-year Treasury yield will likely trade in a range of approximately 1.85% to 3.00% in the next 12 months. This range is constrained at the upper end by our view that global inflation remains low, global growth remains slow, and these longer-term, fundamental factors aren’t likely to change dramatically in the near term.
Besides interest rate normalization, U.S. inflation is a growing concern for the Fed. It was a worry prior to the election because of rising U.S. wages, health care, and housing costs. Concern also flared up due to the anticipated one-two combination of continued accommodative monetary policy (interest rates remain relatively low) and increased fiscal spending in a Trump administration, including infrastructure and defense spending.
For these reasons, we believe the Fed is on “inflation watch” now, and so are we. We believe investors should consider inflation-protection securities and strategies as part of an overall risk-management strategy for their portfolios.
Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.
Diversification does not assure a profit nor does it protect against loss of principal.
The opinions expressed are those of Dave MacEwen and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.