The road to interest rate normalization in 2017

Holland 150 x 150Tim Holland, CFA, Senior Vice President, Global Investment Strategist

Since 1965, the Fed has implemented policy tightening 15 times and the impact on the bond market has not always translated into longer rates rising. For example, in 2004 the Fed began raising rates in response to concerns of a housing bubble. As a result, the bond market did well as the yield on the 10-year Treasury fell.

More recently, during the current market cycle, the Fed increased rates by 25 basis points in December 2015. The 10-year Treasury yield fell and the bond market generated a positive return while equities plummeted in the first quarter of 2016. A year later, the Fed increased rates by 25 basis points in December 2016. The impact on markets was minimal with both equities and fixed income generating strong positive returns in the two months that followed. Year to date, equities and bonds have rallied in the face of two rate increases by the Fed; first in March and then in June. We expect one more rate increase in 2017.

shutterstock_124163875 resizedCatalysts for higher interest rates

Many positive factors are currently present in the U.S. economy that justify and support a move toward interest rate normalization:

  • Stable U.S. economic growth. U.S. economic growth has been modest but steady. The new administration and an all-Republican government will try to stimulate the economy through reflationary policies including tax cuts, infrastructure spending and a more benign regulatory environment.
  • Supportive credit environment. High yield credit spreads have meaningfully contracted and are back to the tight levels we saw in 2014.
  • Inflation expectations. Historically, there has been a strong positive correlation between interest rates and inflation. Many of the anticipated policies of the Trump administration are inflationary. In addition, the Brinker Capital investment team believes the economy is in the second half of the business cycle, which is typically characterized by wage growth and increased capital expenditures—both of which eventually translate into higher prices. We expect inflation expectations to move higher.
  • Unemployment levels. The labor market has become stronger and is nearing full employment. Unemployment has dropped to a level last seen in 2001.

A rising rate environment should prove challenging for some areas of fixed income.  However, fixed income can serve as the ballast for a broadly diversified portfolio and a good counter to equity market volatility.  Our fixed income exposure is focused on strategies with below average duration and a yield cushion.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

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