Fed Watch: Here Come Those Tears Again

Head of Fixed Income Strategy
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That didn’t take long, now, did it? Of course, we’re referring to the Federal Reserve’s (Fed) next policy meeting, which is slated for next week, January 31/February 1. For the record, this convocation will not include any updated FOMC forecasts, nor will it be followed by a press conference from Janet Yellen. Instead, the money and bond markets will be left to digest only the accompanying policy statement. 
In our opinion, it seems highly unlikely the policy makers will decide to raise the Federal Funds target at this gathering. To be sure, we are subscribers to the notion that the voting members do not want to spring any unexpected rate hikes on the markets, despite the fact that Fed officials like to point out that their policy meetings should be viewed as “live” events. At this point in time, there has been no indication the Fed has prepared the markets for such an event, and perhaps more importantly, the economic data that has come in since their December 2016 gathering has not revealed a landscape that would necessitate another lift in the Fed Funds Rate so soon, especially with the uncertainty quotient being dialed up regarding the potential for some fiscal stimulus, now that Inauguration Day is behind us.
Fed Chair Yellen made two public appearances last week that cast an interesting light on current Fed thinking. The recurring theme seemed to be that policy makers are more pleased with how developments are playing out with respect to their dual mandate, “maximum employment and price stability,” and how they believe they are close to achieving these dual goals. Against this back drop, Yellen stated that she “can’t tell you” when the next rate increase may be coming but reiterated that the Fed expects a “few” rate hikes this year and in 2018, a forecast that was first made public at the December FOMC meeting. As a reminder, this median forecast (the “Blue Dots”) called for three increases in the Fed Funds target range for this year, so I guess that was what was meant by “a few’.” 
In contrast to that forecast, the money and bond markets are still not convinced. As of this writing, Fed Funds Futures are priced for only two rate hikes this calendar year, a situation that seems eerily reminiscent of where we were a year ago, when Fed officials were guiding the markets to operate under the assumption that their projection for four increases would be appropriate. Needless to say, the fixed income arena thought this was too aggressive a forecast too. We all know who “won” that one and wonder who will be singing “Here Come Those Tears Again” when calendar year 2017 is completed—the FOMC or the money and bond markets.
WisdomTree is projecting that the Fed will raise interest rates twice this year, with a tilt toward three increases, depending on the outcome of fiscal policy. Investors looking to mitigate potential interest rate exposure may wish to examine the benefit of floating rate Treasury securities notes (FRNs). FRNs are based on a reference rate that is determined at the weekly three-month Treasury Bill auction. Given the potential for additional increases in the Fed Funds Rate in 2017, some “Fed protection” seems warranted. Against this backdrop, we feel investors may be better able to insulate their bond portfolio utilizing a floating rate product such as the WisdomTree Bloomberg Floating Rate Treasury Fund (USFR), as compared to a more traditional fixed income investment.  

Important Risks Related to this Article

Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. 
There are risks associated with investing, including possible loss of principal. Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. The issuance of floating rate notes by the U.S. Treasury is new and the amount of supply will be limited. Fixed income securities will normally decline in value as interest rates rise. The value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
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About the Contributor
Head of Fixed Income Strategy
Follow Kevin Flanagan
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income-related content and travels with the sales team, conducting client-facing meetings and providing expertise on WisdomTree’s existing and future bond ETFs. In addition, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was Managing Director and Chief Fixed Income Strategist for Wealth Management. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S in Finance from Fairfield University.