Bond Market: What’s next?

September 6, 2017

4 minute read

by Drew O'Neil, Fixed Income, Raymond James

For the past few months, interest rates have been trading in a fairly tight range as traders can’t seem to decide which directions rates are/should be heading. For those of us without a working crystal ball, the future is always uncertain. Predicting the future is impossible but oftentimes if you take the time to give something a fair amount of thought, you can come up with an educated guess as to what the logical likely outcome might be. But taking a look around at the current economic and political landscape, something seems different and even the clearest crystal balls seem cloudier than usual. Maybe it’s just that our confidence shattered after the “expert” predictions and polls that are typically taken as gospel have been failing us recently (recall the predictions pre-Brexit vote and pre-2016 Presidential election), or maybe we are just in unprecedented times.

There are many things “up in the air” right now, which, depending on their outcomes, could swing things one way or the other. In an attempt to highlight the uncertainty, a few of these potentially market-moving events/non-events are noted below.

“Normalizing” the balance sheet
- The big question here is what the effect is going be on interest rates once the Fed starts to reduce their balance sheet. Everyone has their theory, but in reality, no one knows how this is going to affect things. The Fed, or any other central bank, has never had a balance sheet of this size and tried to reduce it, so there is no historical situation to reference or economic model to plug numbers in to.
- Clouding the picture even more is the notion that the Fed does not operate in a bubble. In addition to domestic forces, interest rates are influenced by the global macroeconomic landscape. Even if “normalization” could be perfectly modeled, you still have to account for global influences.
Gridlock in Washington
- Again, we find ourselves in an unprecedented circumstance that is impossible to forecast. We have elected an outsider attempting to “drain the swamp” and at the same time get legislation pushed through via established insiders. Things that seemed as if they would fly through Congress on inauguration day have seemingly made little to no progress. We are being told that a tax reform package will be passed by year end, but we were also told that the Affordable Care Act would be repealed by now, and we all saw how that turned out.
The next rate hike
- You could argue that the confidence boost and language surrounding a rate hike would have a bigger effect than a 25 basis point increase in the overnight rate, but regardless, the markets seem divided. Some Fed members are calling for another rate hike in 2017 while others are saying that there is no reason to move again in the near future. And then there are Bloomberg market based estimates that do not have the odds of another rate hike above 50% until June of 2018 and not above 70% until December of 2018.
North Korea
- The ultimate unknown. They seem intent on starting a major conflict with someone, be it the United States, Japan, South Korea, or anyone else. Is there any bite to the bark? No one really knows. They seem to be getting bolder with their missile tests and verbiage, but whether this escalates into an actual conflict or not is still anyone’s guess.

We could come up with 50 more bullet points if we wanted to, but you get the point. There are so many uncertainties that could potentially affect the market in the near to intermediate future that trying to paint a picture of what the world is going to look like a year from now is impossible. Predicting the outcome of any one of these situations is hard enough. Now try correctly predicting the outcomes of all of them and modeling how their combined results are going to interact with each other. Next, take that hypothetical situation and tell me exactly what the effect is going to be on financial markets. How’s your crystal ball look now?

So what does this mean for investors today? Don’t try to predict the future, it is a fool’s errand. Take a look at the current landscape, assess your individual goals. Figure out how you can accomplish those goals based on the current environment, NOT on what the world may or may not look like in the future.

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