FOMC Watch: Float Like A Butterfly, Don’t Get Stung By A Bee

The results of the May FOMC meeting are scheduled to be released at 2 p.m. Eastern time today. The usual accompanying policy statement will be made available, but there will be no economic projections or press conference this time around. The expectation is for no rate hike at this convocation.

As of this writing, the markets placed only a 34.2% chance for another rate increase at this meeting, according to the Fed Funds Futures implied probability figure. This is not a reflection of any shift in Federal Reserve (Fed) attitudes, as additional rate hikes are still anticipated for later this year and into 2019. To provide perspective, the implied probability for the June 13 gathering stands at 92.0%, underscoring the fact that another move is widely expected. In fact, a total of two further tightening moves for 2018 are fully priced in at this point, and depending upon how upcoming data comes in, there is still a debate about whether three additional hikes could be forthcoming. For the record, the Fed’s latest “blue dots,” or its in-house projections for the Federal Funds Rate, looked for two more increases this year and three hikes in 2019. In fact, the Fed also estimated that it would continue to raise rates twice in 2020, but let’s not get too far ahead of ourselves.

What Should Fixed Income Investors Focus On?

The second leg of the rise in the U.S. Treasury (UST) 10-Year yield came rather abruptly, and with a notable milestone. In the most recent two-week span, the yield jumped 25 basis points (bps), breaching the 3% threshold in the process. While we could all debate where we think the 10-Year yield is headed from here, there appears to be one crucial point not really up for such conjecture: The Fed is expected to continue raising rates.

Against this backdrop, investors should be considering strategies to address this potential outcome, as some Fed protection seems warranted. In our opinion, an optimal solution is the 2-Year Treasury floating rate note (FRN) space. The interest rate for an FRN “floats” or gets reset at the weekly 13-week t-bill auction. As the Fed raises rates, the rate hike is reflected in this t-bill auction, not only offering investors a rate hedge for their portfolios, but also providing the opportunity for higher yield enhancement.

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