The Fed’s recent decision to raise short-term interest rates was a welcome vindication to investors who had theretofore been certain of a hike from the regulator. The rate hike was only the second hawkish turn the regulator has undertaken in a decade, and some see it as the cue to end the era of low interest rates. Franklin Templeton’s Chris Molumphy, however, believes that it will be a slow burn.
“Overall, we think the Fed’s move was a healthy course, given the unusually low level the federal funds rate has been at for a long period of time,” Molumphy, chief investment officer of the Franklin Templeton fixed income group, said in a note. “We expect the time frame for the next rate hike to likely contract going forward, but we see the pace of increases being extremely gradual, something on the order of 0.75% per year for the next couple of years.”
Commenting on implications of rising rates for fixed-income investors, Molumphy noted that the effects on fixed-income instruments would vary depending on the asset class and the interest rates they respond to.
“In terms of different types of asset classes within the fixed income space, it’s difficult to generalize because different asset classes are driven by different factors and have different interest-rate sensitivities,” he said. “[L] everaged bank loans, which are floating rate in nature and very low-duration assets, could do well in a rising short-term interest-rate environment… Meanwhile, municipal bonds have suffered recently, because they tend to be longer-duration assets.”
As for other headlines predicting increased fiscal spending from Donald Trump’s administration, he is similarly cautious. “When we look at the details in terms of the amount of these two potential initiatives and the timing, we think the market is likely overstating the effects to some degree,” he said. “US debt has roughly doubled in the past six-to-seven years, so we have a starting point of roughly 75% debt-to-gross domestic product, which is fairly high. And, the US annual deficit has already bottomed… it’s hard for us to envision significantly higher deficit-related spending.”
He also noted that implementation of infrastructure projects would probably be delayed, while the size of a potential tax reform bill has been reduced from US$10 trillion over a decade to just US$3 trillion.
“We are cautiously optimistic that the backdrop of potentially lower regulation and lower taxes could be a net positive for US economic growth and the corporate environment broadly, but many of the potential changes are likely easier said than done,” Molumphy noted. “The markets may be overly exuberant about some of the potential positive changes coming down the path, and we think the exuberance should probably be tempered a bit.”
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