The two-day Federal Open Market Committee (or FOMC) meeting will begin on March 15, 2016, and market participants will be closely watching for clues about when the US central bank may raise interest rates again. After the interest rate cuts announcements in the Eurozone, Japan, and New Zealand, investors are confident that the US economy is strengthening, albeit slowly, and is gearing up for another rate hike.
We expect that the Fed won’t hike interest rates in this meeting, but that it may announce another rise in mid-2016. The Fed will assess the global financial scenario as well as how commodity prices are moving. It also wants to see how the Chinese economy is faring.
What do the economic indicators suggest?
According to the US Labor Department, initial jobless claims declined by 18,000 to a seasonally adjusted 259,000 for the week ended March 5, 2016, which indicated that the labor market is strengthening. Non-farm payrolls increased by 242,000 jobs in February, and the unemployment rate was steady at 4.9%. Personal consumption expenditure (or PCE) index, the Federal Reserve’s preferred measure of inflation, has also risen. The Fed’s target inflation rate is 2%. Further, the rise in consumer spending and an uptick in the manufacturing index have reduced the fear of recession. Thus, improvement in the labor market and firming inflation is readying the path for a rate hike.
FOMC participants expect inflation to gradually rise to its mandated level of 2% due to an increase in wage growth, better resource utilization, and hopes that the rise in the dollar (which suppresses imported goods’ prices) and the fall in energy prices (XOM) (COP) (CVX) will dissipate in the medium term.
Federal Reserve vice chair Stanley Fischer said during a speech in Washington, “we may well at present be seeing the first stirrings of an increase in the inflation rate-something that we would like to happen.”
If you believe that inflationary pressures will require four or more rate hikes in 2016, you may decide to move to a short or intermediate maturity bond mutual fund like the Oppenheimer Limited-Term Government Fund Class A (OPGVX), the American Funds The Bond Fund of America Class A (ABNDX), or ETFs like the iShares 1-3 Years Treasury Bond Fund (SHY) or the iShares 7-10 Year Treasury Bond Fund (IEF).
Mutual funds like the Lord Abbett Floating Rate Fund Class A (LFRAX), which invests in floating-rate instruments, are also an option in a rising interest rate environment. In case inflation begins to surge, funds like the Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX) will protect your investment against inflation.
In the next article, we will look at the 30-year Treasury bond auction.