Navigating crosscurrents of Fed policy, growth and spreads Navigating crosscurrents of Fed policy, growth and spreads\images\insights\article\tara-river-canyon-small.jpg January 11 2022 January 3 2022

Navigating crosscurrents of Fed policy, growth and spreads

Three things to watch in 2022.

Published January 3 2022
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Pace of rate hikes At its Dec. 15 meeting, the Federal Reserve made a strong hawkish pivot on its tapering and rate hike policies. We’re now expecting that tapering will be completed in March 2022 instead of June 2022. Also, we anticipate three hikes in the Fed’s target rate in 2022 with the first as early as June. Beyond 2022, there may be three more hikes in 2023 and two in 2024. Obviously, relative to longer-term bonds, the ultrashort  securities in which we invest are less affected by rate hikes, including floating-rate securities that reset in line with Libor or the secured overnight refinancing rate (SOFR). Nonetheless, we’re keeping a close eye on the Fed and developments that may further impact interest rates. Looking ahead to a monetary tightening cycle, we’re selectively and gradually shortening the duration of our portfolios, always aiming to optimize that delicate balance between a security’s interest rate sensitivity and its yield potential.

Prospects for a continued economic recovery A growing economy is a tailwind for most asset classes and short-duration bonds are no exception. Current strong employment data, robust consumer spending and low default rates are particularly supportive of asset-backed security sectors like auto loans and leases, credit card receivables and equipment leases. The bipartisan infrastructure deal has longer-term potential to bolster the overall economy. On the other hand, inflation, supply chain issues and possible impacts from Covid-19 variants will certainly be on our radar.

Credit spreads In more credit-focused portfolios such as ours that invest primarily in asset backed securities, corporate as well as some high-yield bonds, we are particularly focused on credit spreads—that is the difference between the yield of a corporate bond and a comparable no-risk government security. Unfavorable economic conditions overall as well as black swan events, like the Covid-19 pandemic, can result in a widening of credit spreads and subsequent decline in bond prices. Positive factors such as an expanding economy, strong GDP growth and low unemployment help reduce or “tighten” credit spreads and can result in increases in bond prices. As noted above, we expect the economic recovery to continue and the pace of rate hikes to be gradual, limiting volatility and preventing a substantial widening of credit spreads.

Tags 2022 Outlook . Fixed Income . Liquidity .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

London interbank offered rate (Libor): The rate at which banks can borrow funds from other banks in the London interbank market. The Libor is fixed on a daily basis by the British Bankers' Association and acts as a benchmark for other short-term interest rates.

Secured Overnight Financing Rate (SOFR): a broad measure of the cost of borrowing cash that is collateralized by U.S. Treasury securities. The New York Fed publishes SOFR on a daily basis.

The value of some asset-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private guarantee and/or insurance, there is no assurance that private guarantors or insurers will meet their obligations.

Ultrashort bonds and portfolios of ultrashort bonds are not money market securities and these securities and portfolios will fluctuate in value.

Federated Investment Management Company