Fed Chair Janet Yellen gave a closely watched speech to the Executives Club of Chicago last Friday, which she used as a platform to lay out her economic outlook prior to the central bank’s March 14-15 Federal Open Market Committee (FOMC) meeting.
Yellen stated, “We currently judge that it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect. The process of scaling back accommodation has so far proceeded at a slower pace than most FOMC participants anticipated in 2014.”
“Looking ahead, we continue to expect the evolution of the economy to warrant further gradual increases in the target range for the federal funds rate. However, given how close we are to meeting our statutory goals, and in the absence of new developments that might materially worsen the economic outlook, the process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016.”
“Because my colleagues and I expected that labor market conditions would continue to improve and that inflation would move back to 2 percent over the medium term, we anticipated that the time was approaching when the economy would be strong enough that we should start to scale back our support. The U.S. economy has exhibited remarkable resilience in the face of adverse shocks in recent years, and economic developments since mid-2016 have reinforced the Committee’s confidence that the economy is on track to achieve our statutory goals.”
“However, partly because my colleagues and I expect the neutral real federal funds rate to rise somewhat over the longer run, we projected additional gradual rate hikes in 2018 and 2019. To that end, we realize that waiting too long to scale back some of our support could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession. Having said that, I currently see no evidence that the Federal Reserve has fallen behind the curve, and I therefore continue to have confidence in our judgment that a gradual removal of accommodation is likely to be appropriate.”
Her remarks primed the bond market for a probable quarter-point hike, which bond futures traders have pegged as having an 80% chance of happening. This puts the Fed on course to raise rates at their stated goal of three times this year, while opening the door to further hikes for the next two years out, as per her speech text. It will be interesting to see if the Fed starts to factor in some of the Trump agenda in its thinking. Lower taxes typically lead to higher spending at both the corporate and personal level. The gauge to pay close attention to is wage inflation, which carries the most weight among all inflation data.
With the groundwork getting more clearly laid out for tighter monetary policy, it should be no surprise that income-bearing assets that are tied to short-term interest rates will come under strong and consistent accumulation in the months ahead. High-yield securities in floating-rate business development companies, adjustable-rate mortgages, commercial finance real estate investment trusts (REITs) and convertible debt on mega and regional banks are in the catbird seat against this rising rate backdrop. There are a few ways income investors can thrive in this unfolding landscape, and the best part is that it’s still early.
Within the Cash Machine model portfolio that I oversee, there are three commercial finance REITs paying an average of 10.23%, two floating-rate business development companies paying an average of 8.45% and one adjustable-rate mortgage REIT paying 9.94%. I’m hot on the trail for some convertible bank debt that will round out our exposure of having roughly 25% of total assets allocated to high-yield financials that benefit from the tailwinds of rising interest rates paying a blended yield of around 9.50%. This is as good as it gets for stated yield and potential capital appreciation that is what is one of, if not the hottest, sectors in the stock market.
If you like this kind of blueprint for managing income in an up-rate market within a well-defined portfolio that kicks out an almost 10% dividend yield, then click here to learn about Cash Machine to become familiar with the strategy. Now is the time to highly consider lightening up on long-dated fixed-income assets and putting to work a game plan that is already locked and loaded for what lies ahead with the Fed and its stated objective of normalizing rates.
In case you missed it, I encourage you to read my e-letter column from last week about how to increase income from the global reflation trade that is occurring right now.