Economic and Interest Rate Forecast for 2015Author: Thomas ByrneLast Updated: December 30, 2014 In spite of the recent dovish comments by the Fed, our base case scenario is for the Fed to begin tightening at the September 2015 FOMC meeting. However, there is a chance that the Fed tightens in June and a chance it tightens in 2016. Bond Squad’s opinion is that structural economic sluggishness in Europe and Japan persists.We consider it unlikely that the ECB will engage in U.S.-style outright QE and the economy would remain sluggish even if it did. As for Japan: What about “demographic crisis” is difficult to understand? Until policymakers restructure and refocus the economy to reflect demographic and global economic realities, Japan will continue to combat deflation. Monetary policy has lost its stimulative power in Japan. When interest rates remain low for decades, they become the norm, rather than stimulative.Bond Squad believes that we are in an era of secular disinflation. Globalization and technology have lowered the cost of doing business, made the world a smaller place and have increased competition for jobs. As such we believe wage pressures should remain modest in the United States. This points to another year of sub-2.00% inflation. This could keep the Fed on the sidelines for much if not all of 2015. Bond Squad believes that accommodative Fed policy is actually holding down inflation by allowing businesses which would be uncompetitive (or unviable) with neutral monetary policy, to compete with truly viable businesses. When many businesses battle for market share, prices tend to decline. In the past, business creation led to stronger job and wage growth. This pushed prices higher and made more businesses profitable. However, today we have supplies of goods and services which often outstrip demand (oil is an example). Fed policy might be allowing some businesses to survive which might not do so otherwise. If the Fed tightened a bit, it could squeeze out some of this excess supply and inject a little inflation into the economy. There is such a thing as too much of a good thing, even as it pertains to monetary policy.With the Fed on the sidelines for now, inflation low and the demand for fixed income expected to remain robust in 2015 (and well beyond), we expect the yield curve to remain fairly steep, but should experience noticeable flattening, when and if the Fed tightens policy.The U.S. economy will probably not be able to decouple from the global economy, but an accommodative Fed (albeit less so), low oil prices and low inflation/wage pressures should keep the economy chugging along. However, growth should become increasingly concentrated among companies with the strongest fundamentals. Bond Squad is not risk-off in 2015, but we are risk-smart. Bond Squad judges every opportunity on its own merits.Readers might be surprised that our interest rates forecast is fairly tame. What needs to be understood is:Long-term Rates are sensitive to inflation pressures. Low inflation equals low long-term rates. Short-term rates are the province of Fed policy. A good portion of policy normalization was probably accomplished via asset purchase tapering. Since Fed tapering is, effectively, a rolling back of monetary stimulus, it is unlikely that the Fed will need to raise the Fed Funds Rate neither quickly nor far. If we were pressed to make a 2016 Fed Funds Rate forecast, knowing what we know today, we would put it somewhere between 2.00% and 2.50%. The Fed Funds Rate could peak at those levels. As the Fed raises short-term rates, the long end of the curve could begin pricing-in the effects of less accommodative Fed policy. This could result in a fairly flat yield curve at relatively low interest rates.By Thomas Byrne – Director of Fixed Income – Investment ConsultantThomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.