All expectations are that the Federal Reserve is likely to raise its key benchmark rate for the first time in nearly a year when it meets Dec. 13 and 14, a sign that the economy is on solid footing, strategists said.
Brian Jacobsen, chief portfolio strategist for Wells Fargo Funds, and Brian Rehling, co-head of global fixed income strategy for Wells Fargo Investment Institute, agree that the Fed will likely announce an increase of 25 basis points, or 0.25 percentage points, for a new target of 0.50 – 0.75 percent. The rate — known as the federal funds target rate — is the base rate that affects all other interest rates in the economy.
Jacobsen and Rehling don’t anticipate the Fed suggesting more than two hikes in 2017 after a December increase, describing the Fed as being in a wait-and-see mode at the moment. Wells Fargo Investment Institute’s 2017 year-end target for the federal funds rate is 1 to 1.25 percent, according to its 2017 Outlook, “Seeing Things Differently” (PDF).
“If President-elect Trump’s economic policies are effective over time, it could steepen the path of rate increases — but this is unlikely in 2017,” said Rehling.
Investment portfolio considerations
With a few rate hikes on the horizon, now could be a good time for investors to align portfolios with their long-term allocation goals, strategists said.
Jacobsen said he thinks some investors have been concentrating their assets in cash for too long and sees opportunities in short-term, high-yielding, fixed-income investments, because they aren’t as sensitive to movements in interest rates as Treasury securities. The short-term nature of the investments means they aren’t that affected by rising rates (PDF), and the high-yield component means there are decent interest-income opportunities, he said.
“The high-yield component means that as long as the Fed is hiking into economic strength, the companies should be able to continue servicing their debt, and interest income should be able to offset any rise in yields,” said Jacobsen.
Rehling added, “If the Fed indicates it’s raising rates because of economic support, shorter-duration investments, which aren’t affected by rising rates, and adding credit exposure could be good strategies for fixed-income investors.”
Expected market and economic impact of a December rate increase
Below are some of the key markets and economic areas that strategists said may be affected by a December rate hike:
- Mortgage and consumer interest rates: This year, mortgages and consumer interest rates returned to where they were when the Fed last raised rates in December 2015. So, these rates are not expected to be affected by a December hike, since they’ve already adjusted to a potential hike.
- Equity markets: Markets could be influenced by a hike, though equity markets should be able to take it in stride as the hike is widely expected. Equity markets could face headwinds down the road, however, if the U.S. dollar continues to strengthen and rates continue to rise.
- Bond market: The bond market has likely already factored in a 25-basis-point increase, and therefore should be little changed. If the Fed stays the course — repeating what it said in September when it last updated its summary projections — then longer-term rates could fall a bit despite the hike.
- U.S. dollar: The build-up of anticipation ahead of a hike can strengthen the dollar and then some weakness can occur when the hike happens, which Jacobsen refers to as a “buy the rumor, sell the news” phenomenon.
- Commodities: A December hike alone likely won’t mean much for commodities prices. However, if economic data signals a downturn following the hike, then commodity prices could experience a drop.
- Inflation: “Inflation is crawling like an inchworm toward the Fed’s 2-percent target,” said Jacobsen. That’s a good thing, as a slower rate of inflation growth will likely lead to a slower pace of interest-rate hikes.
Bottom line for investors
If a December rate hike occurs, strategists say to be prepared for two more in 2017. According to Jacobsen, most investors should be comfortable with the idea of a rate change nearing, as there hasn’t been one in a year.
“The first one is always the hardest,” said Jacobsen. “The second one should be a lot easier.”
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