The Week Ahead

Welcome to “The Week Ahead” where each week we take a moment to provide our thoughts on what we can expect in markets and the economy for the week ahead.

Central Banks have been the focus of market investors the past two week as the Fed, European Central Bank (ECB), and the Bank of England (BoE) have had policy decisions to make. We saw the ECB hold rates steady while ruling out further interest-rate cuts as a first step toward ending their stimulus program. The BoE held rates steady as well but in a surprising twist, three committee members voted for a hike. It’s clear that central bankers across the world are taking steps to normalize interest rate policies and balance sheets.

Here at home, the FOMC raised the Federal Funds rate target range to 1-1.25% on Wednesday, the second rate hike of 2017 following the hike in March. This puts them right on target for the three hikes anticipated in 2017. The median dot plots continued to show three hikes for 2018. More importantly, the committee expects to begin the process of balance sheet normalization “this year” and “relatively soon” despite the recent weak economic data. The Fed provided more details on their balance sheet reduction plan, basically utilizing caps in gradually reducing the Fed’s Treasury and agency MBS holdings- starting these cap sizes at $6 billion and $4 billion, respectively, and increasing them quarterly to terminal sizes of $30 billion and $20 billion, respectively.  At $50 billion combined a month, $600 billion a year, it would take a little less than six years for the Fed to fully unwind their balance sheet. The Fed seems committed to normalizing which lays the base case of normalization starting in September and the third hike for 2017 in December. 

Domestic equity markets closed mixed to flat as the Fed hike was priced in well over 90% earlier in the week. Interestingly enough, similar to the March rate hike, the 10-year U.S. Treasury actually declined.  What does this all mean for investors? In a global rising rate environment we continue to prefer credit exposure (corporate debt, high yield, and floating rate) in lieu of high quality (U.S. Treasuries) and a shorter duration fixed income profile as we believe the coupon payments in long maturity bonds will have a difficult time covering the principal depreciation as rates continue to rise. 

Data deck for June 18-24: