Up until the Federal Reserve’s historic December meeting, when the central bank increased its policy rate for the first time since 2006, investors were
fixated upon when the Fed might finally move its policy rate up from the range of 0%–0.25%. The Fed set the rate at the zero bound in 2008 to combat a
plunge in economic growth and to fight disinflationary pressures tied to the debt deleveraging process.
After the Fed’s 25 basis point (bp) December increase, investors are now turning their attention to 2016 and to the entirety of the Fed’s interest rate
cycle. What should investors expect, and how should they position their portfolios?
PIMCO concurs with markets on the ultimate speed and distance of the Fed’s path on rates, which is widely expected to be slow and shallow. Out of the eight
policy meetings the Fed will have in 2016 (see Figure 1), no more than four rate hikes are likely to be announced – half the pace of past rate-hike cycles
– with each rate increase likely to occur at meetings when Fed Chair Janet Yellen is scheduled to hold a press conference. (That said, we expect the Fed
will continue to indicate that every meeting is “live” – i.e., that a rate change is possible at any meeting, press conference or not.)
Our base case is for the Fed to announce three 25 bp rate increases in 2016, lifting its target range to 1.0%–1.25% (up from the current range of
0.25%–0.50%). Our expectation is consistent with where the central bank’s core leaders have indicated they are leaning for 2016, but greater than the two
rate hikes that the bond market is priced for, which itself is instructive on how to position fixed income portfolios at the start of 2016.
Notably, the median projection cast by participants in the Fed’s December meeting reveals policymakers expect four 25 bp moves in 2016, strengthening our
conviction that there will be at least three.
Beyond rate hikes, the Fed in either late 2016 or early 2017 will likely begin to gradually shed the several trillion dollars of bonds it
accumulated in its post-crisis bond-buying binge aimed at stabilizing financial markets. When it does, the performance of agency mortgage-backed securities
and perhaps U.S. Treasuries could be negatively affected.
So, what should investors be looking at to estimate how many rate hikes the Fed will actually deliver in 2016? There are three things in particular:
The Fed’s projections provide guidance on the rate outlookOf the three factors, probably the easiest to analyze and translate into the likely number of Fed rate hikes is the labor market, mainly because the Fed
provides a quarterly Summary of Economic Projections (SEP) to serve as a guidepost to judge the Fed’s satisfaction with the progress occurring on the jobs
front (see Figure 2).
Utilizing these projections to prognosticate the Fed outlook for 2016 is fairly simple. Basically, if job growth exceeds the Fed’s projections, there could
be more rate hikes than the Fed’s leadership currently expects (four increases instead of three). If weaker, the Fed could move less than the leadership
expects (two or fewer times). The odds of five quarter-point hikes look a lot lower than the odds of two under current circumstances, especially with the
Fed now placing greater emphasis on realized (versus projected) inflation, as evidenced by this important excerpt from the 16 December FOMC statement:
“In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation
To be even more specific with respect to how to translate labor market trends into the likely number of Fed rate increases in 2016, consider both of these
On the first factor, it is very important to know that the Fed projects a substantial slowdown in job creation in 2016, owing to a decrease in the
amount of available workers and a maturing of the economic expansion, which is entering its seventh year – quite long by historical standards (see Figure
Specifically, the central bank projects monthly job growth to slow from the 200,000 or so pace of recent years to about 130,000 per month in the second
quarter of 2016 and 100,000 per month by the fourth quarter (see Figure 4). As substantial as the decline is expected to be, and as much as it seems
reasonable to refrain from tightening monetary policy at all, what will matter is how monthly job creation fares relative to the Fed’s projections, because the Fed will view a jobs slowdown as normal for the current stage of the business cycle. This is how to
simplistically determine how the Fed might react to incoming jobs data, assuming all else is equal, which of course it rarely is, so keep a holistic
perspective on the broader economic situation (in the U.S. and globally) as well as on financial conditions.
On the second factor, the jobless rate, the Fed expects a decline of just three-tenths of a percentage point (to 4.7%) in 2016, a remarkably small decline
compared with the past four years when it fell a full percentage point per year. As with the pace of job creation, the speed of progress in reducing
unemployment will have a major bearing on how many times the Fed raises interest rates. If, for example, the jobless rate falls below 4.7%, say to 4.6% or
4.5%, this will raise the odds of four rate hikes. A slower rate of decline would make it more likely there will be three hikes or less, depending upon the
speed of job creation, inflation trends and financial conditions.
Inflation trends: not just about the futureAs noted earlier, the Federal Reserve in December emphasized that it will assess the “actual” progress made toward its 2% inflation goal when considering
the timing and size of future rate increases. This is an important transition, with the Fed indicating that the falling jobless rate in itself is not
enough to ensure it will reach its inflation goal. The Fed doesn’t yet know how far the unemployment rate has to fall before inflation picks up.
In essence, the Fed is probing for NAIRU, the non-accelerating inflation rate of unemployment. This is crystal clear not only in the Fed’s inflation
comment but also in the fact that the FOMC lowered the bottom end of its projected NAIRU range three times in 2015, after not having done so at all in the
previous four years. It is therefore critical to elevate the importance of incoming inflation data, even while maintaining a primary focus on the monthly
For 2016, the Fed projects the inflation rate for all goods and services minus food and energy to accelerate three-tenths of a percentage point to a 1.6%
pace (see Figure 2). Use this as a litmus test of how strong the Fed’s inclination will be to raise rates in 2016.
Follow the leaders: three hikes a reasonable baseline for 2016A reasonable baseline for what to expect from the Fed in 2016 can be developed by considering the rate projections of the Fed’s core leadership, which
consists of Fed Chair Janet Yellen, Vice Chair Stanley Fischer and New York Fed President William Dudley. Here we again rely upon the Fed’s latest SEP and
specifically the “dots,” which are projections for the policy rate from individual policymakers. Close inspection of each participant’s publicly expressed
viewpoints suggests that the Fed’s core leadership expects three rate increases in 2016, making three a reasonable baseline.
Conclusion and investment implicationsPredicting what the Fed will do in 2016 is likely to be easier than it has been in quite some time. Start with three hikes as a baseline, and then adjust
the expectation up or down primarily based on labor market trends, putting the jobs data in the context of incoming inflation data. Then consider financial
conditions, because the movement of stocks, bond yields and the value of the U.S. dollar can all influence the U.S. economic outlook and therefore the
Fed’s decisions on interest rates.
The bar for moving five times in 2016 is probably a lot higher than for moving less than the four that the median of policymakers project in the SEP,
because the Fed has made it abundantly clear that it wishes to be cautious about normalizing its policies, saying twice in its December policy statement
that it expects only “gradual” increases going forward.
For fixed income portfolios, our expectation that the Fed will move more than markets are priced for has a number of broad investment implications. That
said, we believe that markets will be well-anchored over the medium term by expectations for global policy rates to stay below historical norms throughout
the rest of the decade.
Fed watching is always more art than science, but in 2016 science is apt to help Fed watchers to delineate what to expect next from the world’s most
closely watched central bank.
LondonPIMCO Europe Ltd 11 Baker StreetLondon W1U 3AH England +44 20 3640 1000
AmsterdamPIMCO Europe Ltd, Amsterdam Branch Schiphol Boulevard 315, Tower A6 1118 BJ Luchthaven Schiphol, The Netherlands +31 20 655 4710
MilanPIMCO Europe Ltd - Italy Corso Matteotti 8 20121 Milan, Italy +39 02 9475 5400
MunichPIMCO Deutschland GmbH Seidlstraße 24-24a 80335 Munich, Germany +49 89 26209 6000
Zurich PIMCO (Schweiz) GmbH Brandschenkestrasse 41 8002 Zurich, Switzerland +41 44 512 4910
PIMCO Europe Ltd (Company No. 2604517), PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Amsterdam and Italy branches are additionally regulated by the AFM and CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie-Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. © 2017, PIMCO.
contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit,
inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with
longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the
current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity
and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally
supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to
greater levels of credit and liquidity risk than portfolios that do not. Investing in foreign-denominated and/or -domiciled securities may
involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. There is no guarantee
that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to
invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment
This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material
has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security,
strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this
material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT
AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively,
in the United States and throughout the world. ©2016, PIMCO.
The information on this web site is for residents of Europe only.
All material contained on the Exchange-Traded Funds section of this website is purely for informational purposes only and is not intended as investment advice. Investors should seek financial advice before making any investment decisions.
The products and services are available only to residents of those jurisdictions. The information on this web site does not constitute an offer for products or services, or a solicitation of an offer to any persons outside of Europe who are prohibited from receiving such information under the laws applicable to their place of citizenship, domicile or residence. Copyright ©2017 PIMCO Europe Limited. All rights reserved.
Are you sure you would like to leave?
You are currently running an old version of IE, please upgrade for better performance.