The Fed Has Raised Rates, but Deflationary Pressures Suggest a Modest Increase
U.S. interest rates may continue to rise in 2016 as the Federal Reserve seeks to normalize monetary policy amid a modestly growing economy. However, the key question facing Fed officials is how far they can go given mixed economic conditions in the U.S. and financial pressures abroad. Many are questioning whether the U.S. economy is strong enough to absorb a meaningful rise.
Deflationary pressures from abroad and a strong dollar are factors that should prompt the central bank to move slower than expected. Many of our portfolio managers expect U.S. rates to remain suppressed for years as the Fed proceeds with caution.
The past two years offered evidence of this trend. As Fed officials have repeatedly voiced their desire to raise rates, the yield on the benchmark 10-year Treasury bond actually declined by nearly a full percentage point as of September 30. Many factors contributed to that decline, including strong demand for Treasury bonds, falling oil prices and the unprecedented expansion of quantitative easing around the world.
Quantitative easing has gone global. Although the Fed halted its bond-buying program in 2014, the European Central Bank launched a new QE initiative in March 2015, to the tune of €60 billion a month. The Bank of Japan has been purchasing ¥6 trillion to ¥8 trillion of assets each month. With bond yields in Germany and Japan below 1%, interest rates both globally and in the U.S. are essentially anchored lower by the weight of monetary stimulus.
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