Against the indications of a healthy economy, it seems increasingly clear that we are in a context of rising rates in the short term; going forward, we expect a likely steady rather than targeted pace of rate hikes as the Fed aims for a more neutral interest rate level. That said, in the context of bond investments it is important to understand that short- and long-term rates do not tend to move in sync because the latter can also be affected by various factors.
As always, this means that the repercussions vary within bond sectors. In our view, the Fed's rate hike is a healthy sign that the Fed reinforces or confirms the show of strength of the US economy in general, especially given the positive labor market performance and business confidence and consumers.
In addition to aiming for a more neutral interest rate level, the Fed is also regaining more influence over the economy. A more neutral interest rate level gives the Fed a broader toolbox going forward should it reverse course. One of our concerns is that if the Fed continues to keep rates low and the economy turns surprisingly negative, the Fed will not be able to stimulate the economy by cutting rates. While the Fed probably won't need bullets in the near term, we believe it is important to have them.
Given the strength of key economic indicators, we believed the Fed was increasingly in danger of lagging interest rate hikes in the near term. It should be remembered that the Fed Funds rate starts at zero, has remained at that level for a long time and is still low by historical standards, despite this latest Fed move.
However, we don't necessarily expect long-term Treasury rates to rise at a similar pace. The XNUMX-year Treasury rate could rise gradually, but probably not at the same rate.
BOND: SPOTLIGHT AREAS
In line with a positive assessment of economic fundamentals in general, despite the strong performance thus far, we continue to favorably evaluate corporate credit, including investment grade and high yield segments, as well as leveraged loans (bank loans). We continue to believe that these sectors could greatly benefit from favorable economic factors.
Within below investment grade corporate credit, the greatest risk has always been distress and default, and so far we have factored in that risk for the US business cycle. We are monitoring the situation closely, but do not see any initial signs of a large-scale credit deterioration, at least in the near term.
We also continue to find the municipal sector attractive from a relative value perspective. Overall, we are optimistic about the fundamentals that are reflected in most municipal tools at the city and state level.
In summary, we therefore expect that the Fed will likely continue to raise short-term interest rates as it targets a more neutral interest rate level along the yield curve and will do so more consistently over time. In light of the strength of the US economy, we view the Fed tightening on a positive note and believe that the bond landscape still offers many potential opportunities for investors.
