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March Fed Funds Rate Hike: Does it Really Matter?

GDP

Other than existing homes sales, the bond market is focused on today’s release of the 2/1/17 FOMC minutes. Market participants will be parsing the minutes for clues which point to (or not to) a March Fed Funds Rate hike. To me, this seems a bit idiotic. It is likely that the Fed hikes the Fed Funds Rate in 2017, probably several times. Does it matter if the Fed next hikes in March, June or September, or at interim meetings, for that matter? Of course not.

I believe the FOMC minutes will contain language which hints at a March hike. However, I do not believe that the minutes will state that March is a near certainty. My warning to readers is:

If your portfolios are positioned in a way that they are advantaged by little or no interest rate normalization and disadvantaged by monetary policy renormalization, you might wish to rethink your strategy. It is my opinion that we have probably seen the cyclical peak of share repurchases and dividend increases. This is not to say that there will not be more of both, but the frequency and magnitude will probably decline.

Interest Rate Hike

There is much debate, this morning, as to whether or not the bond (UST) market is pricing in a March Fed tightening. One well-known media pundit stated that bank stocks are pricing in a March Fed Funds Rate hike, but the UST market is not. I believe he is half right.

This morning, bank stocks are a little weaker, the 10-year note yield has been trading between 2.39% and 2.42%, and the benchmark 2-year to 10-year UST curve is three basis points flatter. All of this points to a more hawkish Fed. As I have said, in the past (ad nauseum); the UST yield curve has flattened 100% of the time, thus far when the Fed has tightened. As long-term interest rates price versus inflation/inflation expectations and tighter monetary policy is anti-inflationary, I see no reason for this trend to be broken, this time around.

A flatter curve, with short-term rates rising faster than or instead of long-term rates can be good for long-dated or perpetual fixed-to-float bonds and preferreds which float off of short-term benchmarks, such as 3-month USD LIBOR. However, junk-rated floating rate bonds and loans could come under credit pressure as higher bond and loan coupons could impair the abilities of junk-rated corporations to service their debt. Logically speaking, tighter monetary policy makes credit more expensive. The negative effects of tighter monetary policy on the cost of credit are regressive in that they tend to most negatively impact lower-rated less-creditworthy companies the most.

Unless there is a major surge in economic growth, many deeply junk-rated companies could find debt servicing or obtaining credit difficult during a potential monetary policy renormalization cycle. In a way, a bet on junk debt (make no mistake, junk debt exposure is a bet), is a bet on the ability of forthcoming fiscal policies (whatever they turn out to be) to generate significantly higher rates of U.S. economic growth. I have my doubts, in this regard.

All trading carries risk. Views expressed are those of the writers only. Past performance is no guarantee of future results. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.
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Thomas Byrne serves ad the Director of Fixed Income for Wealth Strategies Management LLC. Thomas 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. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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