Zero no more!

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After many months of anticipation, the Federal Open Market Committee (FOMC) recently raised the Fed Funds rate by one quarter of a percent, from a range of 0–.25 percent to .25–.50 percent. Fed Chair Janet Yellen said the increase was justified by both substantial gains in the domestic labor market and a generally stronger US economy. This change, which removed the Zero Interest Rate Policy (ZIRP) initiated during the Great Recession, was an important step in the process of “normalizing” interest rates. In making the change, Yellen essentially said an emergency level of interest rates was no longer appropriate. She stated that the Fed will monitor future economic data for signals on whether additional increases are in order. If the economy is strong, rates will continue to rise. If it’s not, they won’t. In theory, a more data-dependent policy should bring greater clarity to financial markets regarding future rate hikes.

The initial (tepid) response of both US stock and bond markets to the Fed’s decision in the latter part of December made it appear that FOMC members had been successful in communicating their intentions. Yellen et al had accompanied their announcement with plenty of dovish statements designed to put markets at ease. Instead of an abrupt rise in rates, the committee told investors to expect a tempered approach, which would, again, be data dependent. Markets appeared to accept the change quite readily.

Something changed immediately after the New Year, however. Intermediate and long-term interest rates dropped considerably, and the S&P 500 fell 6 percent by mid-January. There were certainly other factors at play in the declines (plunging oil prices and ongoing weakness and devaluations in China, for instance), but such a response indicates that some investors believe an increase was unwarranted. Time will tell if the Fed has made an error (we don’t think so), but a portion of the Wall Street community obviously thinks the economy cannot withstand higher short-term interest rates.

Once rates do begin to make a sustained rise, the effects on consumers and business will be fairly straightforward. Borrowers will pay more for auto loans, mortgages, credit cards and revolving credit in general. Returns will also increase on fixed income investments. Money market accounts, certificates of deposit and corporate and municipal bonds will eventually see higher yields. Retirees and savers will finally be able to achieve positive returns, something absent from the money markets for many years!

Fort Pitt Capital has been anticipating a rise in interest rates for over 18 months, and positioning our fixed income portfolios accordingly. The individual bond accounts consist of short-term, laddered portfolios which achieve a reasonable yield during low interest rate periods, but also allow us the flexibility of reinvesting proceeds at higher rates as bonds mature.

As for fixed income performance in 2015, the Barclays Investment Grade 1–5 index and the Barclays Municipal 5–10 index both showed positive results, up 1.06 percent and 3.28 percent respectively. Credit quality was a key differentiator in 2015, as investment grade bonds outperformed their “junkier” cousins. Energy debt in particular played a large part in the negative returns for high-yield indexes in 2015.

The Barclays indexes are meant to reflect the performance of the fixed income segment of the market and may not be an appropriate benchmark for your individual investments.  Indexes are unmanaged and it is not possible to invest directly in an index. Additional information regarding any index is available upon request.

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