Right after last year’s U.S. elections, interest rates moved steadily higher as investors positioned themselves for a quickening pace of economic growth. Yet as 2017 unfolded, a stream of economic reports made it clear that the economy wasn’t quite set to break out on the upside. In tandem, inflation gauges suggested a complete lack of pricing pressures. In response, interest rates steadily moved back to pre-election levels.

So where does that leave fixed-income investors? Does it send them back to the playbook that has been in place for much of the past decade? Not necessarily. Central bank policies are starting to shift directions, and various kinds of fixed-income investments will respond in unique ways.

Before looking at various options, it pays to again take the pulse of central bank policy.

Hands Tied

This is an unusual time to sit on the Federal Open Market Committee (FOMC). The rate-setting committee had hoped to slowly remove accommodative policies, given that the worst of the global financial crisis was clearly in the rearview mirror.

Trouble is, the absence of apparent inflation suggests little need for monetary tightening. Jeff Rosenberg, the chief fixed-income strategist at BlackRock, believes the Fed will raise interest rates by a quarter point in December—and perhaps on more occasions in 2018. “But the impact of rising rates will be very gradual,” he says.

Indeed, the word “gradual” is being tossed around by many bond strategists these days. Mark Kiesel, the chief investment officer of global credit at PIMCO, thinks 10-year Treasurys will yield between 2.00% and 2.75% at the end of next year. Even the upper end of that range is well below the long-term average. Brian Nick, the chief investment strategist at TIAA Investments, says that “there will be a cap on U.S. rates as long as the [European Central Bank] continues to stimulate [through ongoing bond buying]. So rates will remain artificially low.”

Hidden Inflation Pressures?

As noted, the inflation outlook remains muted as far as most strategists are concerned. For example, the personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge, has remained firmly below 2.0% in recent months.

But Ron Temple, co-head of multi-asset investing at Lazard Asset Management, thinks many investors are becoming too complacent about the potential for higher inflation. “The U.S. economy has shifted into a higher gear, and middle-class spending is now powering the economy,” he says. “In response, inflation pressures are starting to build beneath the surface.”

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