Expected interest rate increases

There were changes in the dot plot forecasts, which call for two rate hikes by the end of 2023. (By way of reminder, after the FOMC meets, they release a statistical analysis called a “dot plot.” FOMC participants are invited to make (plot) their predictions for an appropriate Fed funds rate at the end of the year, and each prediction is represented by a dot.) Seven FOMC members expect at least one rate hike in 2022, which is up from four members at the time of the last dot plot release. The chart below summarizes the quarterly rate forecasts through the second quarter of 2022.

Source: Bloomberg, 6/16/2021

Transitory inflation

Although the FOMC anticipated a spike in inflation, they believe it’s transitory as pressures on inflation seem to be driven by temporary factors (such as the economy reopening after the pandemic lockdowns). The Fed is basically calling for “transitory inflation” in the near term, but expectations are that inflation will normalize and move closer to the target inflation rate (around 2%). It is interesting to note that no one on the FOMC has really been pressed on how long “transitory” might mean. Here at Corporate One, we are comfortable with the FOMC’s projections and understand that the FOMC will continue to be data-dependent in their decisions.

News in the global bond market

European bond yields have been at or close to negative in certain maturities since as far back as 2014 (and even longer in Japan). The reinflation of the global economy has caused yields to rise above zero negative territory, which is the beginning of an end of an era of negative rates. The Germany 30 Year Bond Yield is an example; its yield began the year negative and is now trading around 30 basis points. Of course, current bond holders will see gains erode, but this will open opportunities for new investments at positive rates. This could be a harbinger that a period of steady growth is on the way.

Effects on yields

Following the release of May’s Consumer Price Index (CPI) numbers, which were much higher than anticipated (5% year over year), our bond market sold off briefly. However, when the number was absorbed and examined through the prism of the price level prior to the pandemic versus the current level, it confirmed the Fed’s opinion that inflation is transitory; bond prices rallied while yields moved lower. In addition, after the FOMC meeting the yield curve flattened slightly, causing 2-5yr rates to rise, while the 10yr yield continues to trade around 1.50%.

Current investment opportunities

Not much has changed in the markets since the onset of the pandemic. Corporate One continues to see rates on certificates of deposit lag the rates of securities. There actually has been a bit of a compression between the rates on callable securities and non-callable securities, such as U.S. treasuries and U.S. Agency bullets. This compression is typical when you see a move up in treasury rates in certain terms (2-5yrs). The result is a slight shift in volatility, and it becomes less likely that a bond will be called. Less call risk means that the issuer doesn’t compensate the investor as much.

As a result, we have seen a pickup in interest in U.S. treasuries from investors. We also continue to see interest in mortgage-backed securities and collateralized mortgage obligations (CMOs). These securities allow investors to have cash flow to reinvest and typically pick up yield to other securities in the market. If the expectation is that economy will continue to recover and that there is a likelihood for higher rates in the future, securities that adjust to higher rates (floating-rate securities) will perform favorably. Investors need to be willing to give up initial yield for protection longer term.

I encourage you to speak with your senior investment services representative individually or our investment department at 800/366-2677 for specific offerings and availability of these and other opportunities.