The Federal Reserve raised the benchmark interest rate by 25 basis points for the second time in 2017 and revealed how it will start unwinding its $4.5 trillion balance sheet.
After its two-day policy meeting, the Federal Open Market Committee (FOMC) voted to raise the range of the federal funds rate to 1% and 1.25%, confirming what many market players had been anticipating.
Despite the fact that inflation continues to trail the Fed’s 2% target, the FOMC said it expects economic activity will expand at a moderate pace and the labour market would strengthen further.
Speaking at a press conference, Federal Reserve chairwoman Janet Yellen said that with nearly five years of inflation rate running under 2%, she expected the inflation rate to move up and stablise at 2% in 2018 and 2019, which would be in line with the committee's projections.
Speaking to Citywire Selector, Citywire AA-rated Michael Collins, senior portfolio manager at PGIM Fixed Income, said it was a surprise that the Fed gave a passing acknowledgment to the weakening of inflation but the rate hike path remains largely intact.
Collins sits within the PGIM Fixed Income team, which oversees $650 billion in assets.
‘The main theme is that the market was pricing in terminal rate rises to reach 3%. From where they are that would still have to be a fairly aggressive series of moves.
‘We have therefore had a big curve flattener in place and, if the Federal Reserve goes ahead with another rise this year, which is likely after being a 40% possibility going into this meeting, then that would be a good position to be in.’
Collins added that the decision to announce a ‘gradual reduction’ of its balance sheet – which is primarily in government accumulated since the financial crisis as well as mortgage-backed debt - was more eye-catching than the hike itself.
‘The surprising thing is the level of transparency and detail they gave around tapering. They intimated that they would do it later this year,’ he said.
‘If they hike in September it may start October 1 and they will take $6 billion of treasuries and $4 billion of mortgages out of the market and double and double and double from there until the inevitable. That was surprising.’
Collins runs several funds across global bonds, US dollar, US dollar medium-term and US dollar short-term debt.
His best sector outperformance is in US dollar short-term debt, where he has returned 6.7% over the three years to the end of May 2017 against an average manager return of 2.8%, which places him fifth out of 205 competitors.