The Federal Reserve’s announcement Wednesday that it was raising the federal funds rate by 25 basis points—its first hike in a year and only its second since 2006—was widely expected and perceived as already built into the markets. But the Fed’s revelation of plans to raise rates three times in 2017 has drawn some skepticism, even though Fed chairwoman Janet Yellen emphasized during an afternoon press conference that these proposed shifts will be very tiny.
Robert Tipp, portfolio manager of the Prudential Total Return Bond Fund, which has nearly $18.6 billion in assets under management, tells Financial Advisor he’s a little surprised that the Fed plans to effect three more rate hikes next year.
Tipp believes the Fed is moving toward fulfilling its dual mandate of maximum employment and 2 percent inflation. Prospects of fiscal stimulus have also given the Fed a little bit more confidence that it could raise rates without damaging the underlying economic outlook, he says. The Fed, he says, “could also be concerned that hiking rates too slowly would foster a bubble in the stock market.”
However, “it’s a little surprising to see the rate hikes go into effect in 2017, in terms of pace, rather than 2018,” he says. That’s because it seems unlikely to him that the incoming government will be able to execute much stimulus next year. It’s going to take some time for the new administration to settle in and work on complex changes, including health care reform and budget concerns. Instead, he sees fiscal stimulus as a more likely prospect for 2018.
That’s not to say Tipp thinks it’s completely implausible for the Fed to hike interest rates along its “dot-plot”—the interest rate projections made by its policy makers. “Things are progressing in the right direction and it’s reasonable to expect that whatever they were thinking before, it’s looking a little bit better now and therefore they moved the dots up,” he says. He just doesn’t think having so many rate hikes in 2017 is a reasonable base-case scenario, he says.
Looking further out, “the Fed is going to have a hard time raising rates anywhere nearly as rapidly as what they’ve penciled in for the next few years,” says Tipp, “because the dollar will be going up, higher interest rates themselves will have a dampening effect on growth and we don’t know what the impact of the incoming government’s policies will be.”
Tipp doesn’t expect Wednesday's Fed hike to affect the markets, although he says it could have an impact on the margins should the Fed turn more aggressive. “The way economic expansions are crushed and the way stock market rallies end are often the result of overly aggressive rate hikes from the Fed, he says. This process is ultimately generally a positive for fixed income.
Tipp thinks investors should be taking a long-term approach to their investments and diversifying across stocks and bonds.
“They’re going to get a diversification benefit, and they’re going to get reasonable returns on the bond side,” he says.