With market expectations for future US interest rate hikes increasingly diverging from the median forecasts of Federal Reserve (Fed) members, something is going to have to give. Recent concerns over global growth and inflation outlooks and the negative spillover effects to financial markets have caused expectations to be lowered to just about one 25bp hike over the remainder of 2016. Bond markets are likely to be disappointed by policy makers who we expect to maintain a more optimistic view of the economy and thus continue to communicate their expectations for several rate hikes later this year.
The Fed is unlikely to raise rates following its March meeting, choosing a cautious approach to rate hikes in response to the disappointing growth in Q4 2015 as well as heightened growth risks globally. While it is likely the Fed lowers their forecasts for rate hikes over the course of the year, we believe they will do so modestly. Recent indicators for growth show a rebound in Q1 2016 and, importantly, measures of core inflation as well as the unemployment rate are already at or near the Fed’s year-end forecasts. As the Fed reaffirms their forecasts for multiple rate hikes in 2016, we see scope for rates to rise across the curve which will disappoint bondholders expecting continued low rates.
Robert Bayston – Standish, a BNY Mellon company