James Colby, Senior Municipal Strategist and author of the Muni Nation blog at Van Eck Global, talks about what effects the Federal Reserve's recent hike in interest rates will have on the municipal bond market. He also looks at what the Fed might do in 2016 and what he believes is the best strategy to use for municipal bond portfolios.
COLBY: The municipal bond market is a place that doesn't like mystery. It doesn't like suspense. The clarity now of the Fed finally making a move after eight years of virtual zero rate policy is going to offer the admissible investor. An opportunity to now push great concerns aside and focus on on the real value added to the municipal and product provides. What will the Fed do in 2016 is really the next question.
The next step in the phase two, moving towards a normalized interest rate policy. I think it all depends on what happens in the economy. It has been the issue over the last two and a half years as we've waited for the Fed to make a decision. Conventional wisdom says that two, maybe three more rate hikes seem to be likely for 2016. The Fed is suggesting perhaps it's going to be four.
But the market isn't convinced. The market isn't convinced because the economy hasn't shown the consistent resiliency, hasn't shown the consistent growth path that would suggest that inflation is going to get to their target of 2%. I suspect that we're in that two or three rate hike range for 2016. Well, here's the big question. The investors want to know what to do now. How do they position themselves for rate hikes.
One of the things that I've suggested in some of my prior commentaries has been, look back at what happened in the period of 2003 to 2006. That was the last time we were seeing the Fed move aggressively higher in terms of their rate setting policy. That was coming off a very positive economic period of time and environment. What happened to the yield curve? The yield curve flattened, but the real principal damage was done. If you look at it in that fashion was done in the intermediate and short part of the curve as opposed to out long. Real long-term rates remained attractive for municipal investors. They should again this time around. Because CPI, or consumer price inflation rate minus the long rate return of long-term and municipal. It's still positive. You use that same formula applied to the short end of the municipal curve and you've got negative returns. I think the best place to begin look for in investors in this particular stage is intermediate to long in the municipal curve.