Fed to keep funds rate near zero for now
By Laif Meidell, CMT, president of American Wealth Management, and portfolio manager of the AdvisorShares Meidell Tactical Advantage ETF (MATH)
The biggest news to affect the bond market this week came Wednesday from the Federal Open Market Committee meeting, where the Fed funds rate was once again left unchanged. The Fed funds rate is the short-term interest rate in the U.S. that banks are required to pay each other for borrowing reserves, when the bank has a shortfall in its required reserves.
The Fed maintained its statement that it would keep rates near zero for a “considerable time,” even after its bond-buying program ends in October. This increases the likelihood that the Fed will start raising rates in the summer of 2015 versus the spring of next year as some had expected. Additionally, 14 of the 17 Fed officials expect to see higher interest rates in 2015, compared to 12 out of 17 from the June FOMC meeting.
The Fed forecasts interest rates by the end of 2015 to be between 1.25 and 1.5 percent, above the June forecast of 1.15 percent, and between 2.75 and 3 percent by the end of 2016. The good news is that U.S. investors may actually start earning over 1 percent, on average, in their money market accounts by the end of 2015. Most Fed officials see policy rates for 2017 above 3 percent, which is near what is considered to be the long-term normal rate. It appears that once the Fed starts raising rates next year, we’ll likely see successive rate increases continue for a couple of years.
Based on the Fed forecasts, we can expect one of two interest rate scenarios over the next three years:
• The yield curve will flatten as short-term rates rise and longer-term rates remain close to where they are today, or
• Longer-term rates will rise in harmony with short-term rates, possible due to mild inflationary pressures in the next few years, keeping the yield curve in a positive slope, as it is today.
In the first scenario, shorter-term bonds funds will suffer the most as their prices decline with each successive interest rate hike. In the second, most bonds across the spectrum will likely experience a decline in value. Currently, the second scenario seems to be more likely.
Bonds have taken their share of lumps over the past week as investors tried to anticipate the FOMC announcement. For the week, the best-performing bonds index was the Standard & Poor’s International Corporate Bond index, gaining 0.34 percent over the past five trading days. On the other end of the spectrum, the Barclays U.S. 20-plus Year Treasury Bond index and the Barclay’s U.S. Treasury Inflation Protected Securities index declined by 1.23 percent over the same period.
This commentary originally published in the Reno Gazette-Journal. Performance numbers used in this article were obtained through eSignal and are not guaranteed to be accurate.