Central Banks on Full Display Last Week

The quarterly WebEx and conference call that we hosted in mid-January featured our outlook for the fixed-income markets in 2016. That outlook was and continues to be centered on two big questions, both regarding the Fed: 1. Will the Fed really be able to raise rates at its expected pace of four times this year when the market is pricing in less than two? and 2. Will the Fed really be able to “go it alone” and raise rates when other major developed market central banks are easing policy. We received hints about the answers to both questions last week, as the FOMC released a statement after its two-day meeting on Wednesday. In the statement, the Fed mentioned that inflation remains low and that the committee is continuing to monitor developments abroad to assess their impacts on both inflation and the labor markets. The Fed seems non-committal at this point as to whether its March meeting will be “live,” meaning that the committee could raise the Fed Funds Rate by a quarter point. Our best guess, which fits with the market assigning it a 20% likelihood, is that another rate hike is improbable at this point. In related news, the Bank of Japan on Friday cut interest rates into negative territory, following a similar move made last year by the ECB. This rate cut was unexpected and caused risk assets to rally around the world, which is what major newspaper headlines focused on over the weekend. More important to the Fed and the U.S. bond market, however, was that the move caused the U.S. Dollar to rally. The DXY dollar index rose by 1% Friday. A strong dollar hurts U.S. exports (by making them more expensive on the global market) and depresses inflation (by making our imports cheaper), both of which run counter to the Fed’s goals, reducing the likelihood it will raise rates in March. It follows that, at this early point in the year, the call for a range bound rate environment and a steady return environment for U.S. bonds remains in place.

Sources: Bloomberg, Federal Reserve, RBS, WSJ