As widely anticipated, the Federal Reserve Open Market Committee raised the Fed Funds rate by 0.25% last week to a range of 2.25-2.5%. This marked the fourth rate increase of 2018 and the ninth since the tightening cycle began in late 2015. Just as important, the FOMC updated its famous (or infamous) “dot plot,” which details expectations for future rate increases. The committee anticipates raising the Fed Funds rate two additional times next year (down from a previous expectation of three increases). One additional rate increase is expected in 2020 and none in 2021. The committee’s expectation for the “neutral rate,” meaning the rate at which the economy is performing at its long run average, is 2.5-3.5%, meaning the current rate is at the lower bound of what the FOMC would consider “normal.” In his press conference, Fed Chair Powell indicated that the balance sheet runoff process has been smooth and will continue.
Clearly the risk markets did not welcome this news. Stocks and other risk assets sold-off while high quality bonds rallied. U.S. Treasuries saw the best performance in the investment grade markets. Corporates rose in value, but underperformed other sectors. Municipals traded well.
Moving forward, 2019 brings a new level of uncertainty for investors. Monetary policy has tightened and the U.S. economy is set to continue growing. But this growth is expected to proceed at a slower rate, and trade/geopolitical tensions remain high. We believe that financial market volatility is likely to continue into next year, and have positioned our portfolios for it, with a high percentage of AA and AAA rated bonds held across our strategies. At some point next year it is possible that more attractive entry points to take risk in investment grade bonds will present themselves, but we are not there yet. In the meantime, we will continue to let our portfolios perform as investment grade bond portfolios are meant to, with stability, especially in markets such as these.
Source: Federal Reserve