January has been a reasonably good month for income investors as the 10 year treasury ended the month at the same place it started, 2.45%. Even though interest rates remained flat the average price of a preferred share or baby bond continued to climb from December prices. The average share ended the month at $25.68 which is a gain of about 1% on the month. In what has been a typical pattern for years any interest rate move such as the Fed Funds increase in December spur price movements that are initially much greater than are justified, but prices adjust as time goes by. Recall that even before the December Fed Funds rate increase interest rates had anticipated the move and the 10 year treasury was at 2.5%. The average preferred stock had fallen by 4% although high quality low coupon issues had fallen by as much as 6-10%. A seasoned, patient investor, would have anticipated that prices would adjust higher as the overreaction corrected itself.
So where do rates go from here? The Federal Open Market Committee is meeting right now and will be announcing interest rate decisions on Wednesday afternoon. There will be no change in rates Wednesday and we agree with most that a rate hike in March is likely given the information available at this moment. Recall that in December Yellen announced that 4 rate hikes were likely in 2017–we disagree and think given what we know right now 2 is more likely. Last week 4th quarter GDP was announced at 1.9%, after the 3rd quarter was at 3.5%–the consensus was 2.2% so already we are slipping from consensus. Friday will give us a look at employment which is very important in the interest rate outlook and this announcement could be a market mover. Of course the wild card in any market is what the Trump administration does with policy and we are unable to factor this into our outlook. Assuming all data in February comes in at close to expectations we think the 10 year treasury may move somewhat higher (10-20 basis points) in late February in anticipation of a 1/4% Fed Funds increase in March. This is somewhat meaningless to us as we have set our path with purchases of only shorter maturity issues or high yield issues and this won’t be changed.
In summary we believe that rates will remain flat for the next 30 days, but factors outside the norm (the Trump administration) may be responsible for movements that can’t be anticipated by anyone. We have to invest based upon what we believe will happen and simply deal with any special events caused by government when they happen as we can’t foresee what these will be.