Fed Set to Hike Rates but Stay Lower for Longer | American Funds

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December 2015

Fed Set to Hike Rates but Stay Lower for Longer

Fixed-income portfolio manager John Smet discusses the economic conditions underlying the Fed’s anticipated interest rate hike and offers a likely trajectory for future increases.



Kevin G. Clifford
John H. Smet


Kevin Clifford: John, everybody wants to talk about the Fed. When are they going to raise interest rates? I mean, that’s been the dominant theme in 2015. I know there’s not a collective view, but how are you thinking about this?

John Smet: You look at the economy. We’re growing at 2% and 2.25%. It’s not great, but we’re the envy of the world. And I think that 2% and 2.25% is a sustainable growth rate. And unemployment is at 5%. So the unemployment picture looks great.

Now, inflation is not growing. We’re not seeing much growth in inflation. Core inflation is steady, but the headline inflation, which includes food and energy, is really nonexistent. But we think the ingredients are in place that inflation is going to pick up. You’ve got low unemployment. You’ve got low commodity prices, which may surprise on the upside.

So I think all the things are in place. We’ve passed all the tests — Janet Yellen has given all the hints. So rates are going up December 16.

But the real question is, what is that path going to be forward? Because once we get past December 16, the next question is when’s the next rise and what’s the path going to be? We think it’s going to be slow and lower for longer. Think about 1% at the end of 2016; 1.5% to 1.75% in 2017; and maybe 2%, 2.25% in 2018. So low, slow and steady. The economy is probably going to grow at 2%. It’s not going to grow at 4%; I don’t think it’s going to grow at 1% or zero. Inflation is going to come back, but I don’t see it pushing very high. So the Fed’s going to have the luxury of going low for longer.

Now, I think what’ll happen is the bond market will overreact if we get a couple of strong employment numbers and say, “The Fed’s going to go up a lot.” And that’ll be a great sales opportunity. There’ll be other times in 2016 and 2017, you get some weak data, you’ll get the Fed saying something, and then the market will say, “Well, they’ll never raise.” And that’s a great time to buy. So I think we’re really setting ourselves up for a market that'll provide great opportunity for bond investors.

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