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H&W in the Media

Janet Yellen may start ‘reverse quantitative easing’ in 2016

What will the Fed do next…and where should you invest as a result?

Following its meeting last week, the Federal Reserve chose to leave interest rates unchanged again. While I believe that the Fed would like to adopt more of an increasingly hawkish stance given solidifying economic data in the U.S. and mounting inflationary pressures, it seems that it continues to strike somewhat of a dovish tone to appease certain vocal dissenters and those concerned with global economic growth altogether—though it did indicate in the current release that international factors were no longer as much of a concern by removing the previous wording of, “global economic and financial developments continue to pose risks.”

Hence, I am introducing the term “hovish” to describe this current hybrid state of hawkish/dovish positioning by the Fed.

Based on outtakes from the Federal Open Market Committee (FOMC) meetings, we currently believe that there will be two—potentially three—additional rate hikes of 25 basis points (i.e. 0.25%) in 2016, with the next hike likely taking place in June and the following hike in late summer/early fall before the presidential election cycle really starts to heat up.

This would result in a Fed Funds Target rate in the range of 0.75% – 1.00% by the end of 2016. Our forecast is slightly below that of the weighted 2016 target rate forecast of the Fed based on the last released forecasts of the FOMC participants stemming from their December 2015 meeting (see table below) but consistent with what many in the market now believe will be the likely path for this year. We will look to post more recent data in this regard once available.

quantitative

One other notable research firm that our forecast is well below is Capital Economics. It stated in its “U.S. Chart Book” on April 25, 2016, that it expects the next rate hike to be in June, with the fed funds rate reaching 1.00% to 1.25% by year end and 2.25% to 2.50% by the end of 2017.

Looking to next year, the weighted Fed Funds target rate for 2017 currently calculates to a rate of 2.29%, though we presently believe that the target rate will likely be closer to 1.75% – 2.00% by the end of 2017.

As a result, based on current data and forecasts, it is fair to conclude that interest rates will remain at historically low levels for the foreseeable future.

At Hennion & Walsh, we still contend that going forward, the Fed will likely follow the blueprint that it utilized during the 2004-2006 tightening period when it gradually raised the Federal Funds Target Rate on 17 different occasions in 25 basis point increments over this time frame.

“Reverse quantitative easing”

The only difference during this round of tightening that we see is that the Fed may also consider starting to slowly shrink the size of its U.S. Treasurys and Government Agencies securities-laden balance sheet in conjunction with increases to the federal funds target rate.

In other words, instead of just considering raising rates further after each FOMC meeting, it may eventually consider some form of a gradual one-two punch of rate increases and sales of U.S. Treasurys (or non-reinvestment of the principal of existing maturing bonds) off of its balance sheet, though not necessarily after each FOMC meeting.

In this regard, we conducted our own research to observe which sectors of common stocks performed best when the Fed embarked upon its last measured rate increase program during the aforementioned 2004 – 2006 time period.

Recognizing that past performance does not guarantee future results, and that this time around may in fact be different, our research interestingly showed that the top performing sectors of the stock market during this time period were energy (XLE), utilities (XLU), telecommunication services (IYZ), financials (XLF) (led by REITs), materials (XLB) and industrials (^DJI).

Click here to watch the video at Yahoo! Finance.