The FED and tax reform: what's next for fixed income investors?
• Fed: The FOMC decided to raise the fed funds target range for the third time this year to 1.25-1.50%.
• Economy: The US economy is currently benefitting from positive momentum. The delivery of a fiscal package should provide a boost to 2018 and 2019 growth.
• Market: The US yield curve has flattened since early September. If markets continue to reprice fed funds expectations, long-term yields could rebound from the current levels, especially if the extension of the economic cycle caused by tax reform is confirmed.
• In addition to the Fed’s commentary about unwinding and tightening expectations, the details about and timetable for rates policy from the European Central Bank and the Bank of Japan will have broad implications for global interest rates as they shift from accommodation to tightening as their economies improve.
• We favour diverse credit sectors and we believe most US government debt is unattractive. Many credit sectors should benefit from stronger growth, lower taxes and less regulation. Although credit valuations are elevated, a bias towards higher-quality corporate debt is warranted, in our view.
• US dollar: We expect the US dollar to fail to gain traction, as markets have already priced in a prolonged and gradual tightening cycle. Only a sharply upward trajectory for inflation, causing a more accelerated pace of Fed tightening than is currently projected, would change sentiment for the dollar.