Bond Market

Simplifying the Fed's upcoming FOMC meeting

Doug Drabik discusses fixed income market conditions and offers insight for bond investors.

The Federal Reserve (Fed) has caught much attention by the media and general public and rightly so. The President is considered the most powerful person in the world by some and it can be argued that the Fed Chair is a close second. The Fed Chair (Jerome Powell) leads the Federal Open Market Committee’s (FOMC). Sometimes the FOMC’s dealings appear complicated and almost mystic, but let’s see if we can reveal the committee behind the curtain in a more simplistic manner.

The Fed’s most important responsibility is to conduct this nation’s monetary policy. Monetary policy is a set of actions enacted by the central bank (the Fed) to attain economic stability and growth through the use of various activities they are empowered with. The Fed wants to keep economic growth going and unemployment low. Their two most commanding tools are their ability to manipulate interest rates and control money supply.

The news is jam-packed with opinions on the Fed’s intentions toward interest rate policy. Let’s unfold the irony of this statement because there is a distinction important to investors. News used to be a broadcast of events or information, not necessarily opinion. The Fed has been very transparent about its intentions and therefore investors may be better served analyzing how these actions might affect investments rather than speculating on what the actions will be. The Fed has acknowledged their intent to bring Fed Funds to the “neutral” range or to ~2.00%-2.50%.

Notice that the Fed changes the Fed Funds rate which is an influence on the short end of the Treasury yield curve. This rate change in itself does not necessarily control the intermediate or longer end of the Treasury yield curve. There are other ways they can attempt to do this but that is a topic for another day. The Fed’s anticipated moves are built into the current market pricing. The FOMC meets this Tuesday and Wednesday and it is generally expected that they will raise Fed Funds by 50 basis points (bp). When or if this happens, do not expect a whirlwind move in interest rates. The market has already projected this. If the Fed was to change the Fed Funds rate by 75bp or only 25bp, that would signal a divergence from their declaration and would likely have a greater market impact.

The Fed has conceded that inflation is more than transitory, yet they have only recently stopped buying bonds in the open market. Purchasing bonds is an easing policy that injects money into the economy and lowers interest rates. The Fed balance sheet has ballooned to nearly $9 trillion as a result. They are currently engaging in tightening policy by raising rates and allowing bonds to roll off their balance sheet without replacing them. This will take money out of the economy and support higher interest rates. They are indicating they will allow $95 billion from maturing bonds to roll off each month. The market will pay close attention to these FOMC statements this Tuesday and Wednesday.

The Fed is caught in a precarious position of trying to keep the economy rolling, curbing inflation and keeping employment healthy. We do not know whether any of these upcoming rate hikes will control inflation. We do know that the Fed will be better positioned once they get to neutral to impact forward decisions in either direction. We don’t know if consumer spending will continue its pace through the usage of personal savings. We do know that stimulus checks, student loan and rental deferrals are gone and many consumers have fewer disposable dollars to spend. We don’t know how all these variables will play out and whether interest rates will be higher or lower as a result by year’s end. We do know that Treasury interest rates are up significantly year to date (+270% on the 2 year Treasury, +96% on the 10 year Treasury). We do know that corporate spreads have widened out (+49% on 10yr BBB). We do know that municipal yields as a percentage of Treasury yields is significantly higher (+28% on 10yr).

The bottom line - fixed income securities are providing yields exceeding what has been achievable for years. Investors can shore up core fixed income allocations with meaningful yields (+4.00% in 5 year maturities) and modest risks (durations of 1-6). Pay attention to the Fed but keep in mind that attainable benefits are already baked into the market. Don’t miss this opportunity while waiting for what may already be revealed.


The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.

To learn more about the risks and rewards of investing in fixed income, access the Securities Industry and Financial Markets Association’s Project Invested website and Investor Guides at www.projectinvested.com/category/investor-guides, FINRA’s Investor section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.