The US Federal Reserve has announced an increase in interest rates by a quarter point to 1.5-1.75% given the expected inflationary pressures in coming months.
New fed Chairman Jay Powell suggested that the economic outlook had strengthened in recent months as economic activity in the US continues to expand at a moderate pace and labour market conditions remain strong. Core inflation is expected to increase to 2.1% next year maintaining a ‘goldilocks’ type environment.
There is much talk about the Fed dot plot matrix, a key snapshot into the Feds thinking about future rate hikes, and this is now suggesting 2 further rate hikes this year followed by 3 more in 2019.
This move was widely expected by the market, although we saw a slight rally in equity markets and the dollar weakened slightly (GBPUSD at 1.417 at the time of writing).
What is interesting to see is that US ten year treasury yields (ie US government bonds deemed as a ‘safe haven’) have found a new trading range and not yet breached the psychologically important 3% mark.
What does this mean? It means investors are still buying these bonds despite interest rates rising (bond prices move inversely to yields/interest rates), despite a number of market commentators suggesting a widespread selling of bonds is expected, and therefore still form an important part to an overall diversified portfolio.
A prudent measure to take is to reduce the interest rate sensitivity in portfolios by primarily reducing the bond exposure but also taking note of other interest rate sensitive areas of the portfolio which may not be as obvious at first. An example would be property exposure particularly in the form of real estate investment trusts (REITS). Adding to cash and hedge funds can thereby reduce portfolio volatility.
The US continues to generate positive macro data, as the US jobless rate is at 4.1% and expected to fall further to 3.6% next year, in conjunction with controlled inflation.
Central Bank policy will be a driving force for the year and therefore, the key risk to portfolio returns… so keep an eye out for those three bears (Fed, ECB, UK MPC)…
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