DENVER -- Is the economy ready for lift-off -- and set to take interest rates with it?
Not so fast, says Kathy Jones, a Schwab vice president and fixed-income strategist at the firms Center for Financial Research, who spoke about plotting a 2015 strategy for bonds investments at the annual Schwab Impact conference.
Saying that shes heard both market optimists and pessimists advocate a move to riskier assets next year, Jones suggests a different strategy. In her view, the year is likely to bring slow to moderate economic growth, low inflation, a moderate rise in rates and a flatter yield curve.
In those respects, 2015 will be much like 2014, Jones predicts. "Short-term rates are up about 25 basis points over the last year, long-term rates are down from 35 to 60 basis points, and the 10-year Treasury bill hasn't changed much, though there's been a ton of volatility," she says.
Although the economy is gradually improving, she says, the signs of improvement are mixed and relatively mild.
Government spending has picked up after recession, for instance. Government budgets rely on taxes, particularly property taxes at the local level, and the real estate market is reviving. But budgets are still constrained at state and local levels, Jones says.
More companies are investing and making capital expenditures, particularly in the mining, utilities and manufacturing industries. Energy companies have benefitted from the oil boom, but energy prices are falling and that will make it more difficult for these companies which issue debt in the high-yield sector to roll over or service debt.
Unemployment has fallen to less than 6%, but about 7 million people are still under-employed. "There's still slack in the labor market, and that will mean subdued wage growth," Jones says. "Wages should rise with the economy and productivity there's plenty of room for consumers to catch up after flat income growth over the last decade."
Men between 25 and 54 are participating in the labor market at historically low rates, a trend that began in 2000, Jones says. "The U.S. numbers are lower than the comparable figures for France," she adds.
Household formation has slowed, with more people age 18 to 34 living with their parents. "The millennial generation is coming into the job market at a difficult time, when it's tough to find good jobs, housing costs are high, and many people have high student loan debt relative to their incomes. Changing this is a long, slow process. As it changes, it will help fuel the economy. As it is, it drags on economic growth," Jones says.
In the past several years, more credit has been available from the Fed than banks have been willing to use. "Bank credit has lost some momentum, but it's moving in the right direction," Jones says, adding that a Fed funds short-term rate of zero has helped tame volatility.
For bonds, all these factors may combine to make next year a bumpy one. "Next year, we can likely expect moderate growth and higher volatility," she says, "and the uptick in volatility will be felt mostly in the riskier sectors of the market. We're already seeing it in the foreign debt market, and I think we'll see it next in high-yield and other riskier sectors."
Yields are falling and converging in the U.S. and in other developed economies. The dollar is rising, which tends to push inflation down, but also hurts exports, which make up 13% to 14% of the U.S. gross domestic product, and affects developing economies that hold substantial, dollar-denominated debt, Jones said. The dollar could continue to rise over the next year, and maybe even longer. "That's something of a drag on the economy," she says. "We're sort of importing other nations' problems."
In the coming year, wealth managers may benefit from reducing credit risk, paying careful attention to liquidity, considering mid- and longer-term debt, and keeping an eye on bonds' starting yields, which may be a good predictor of their ultimate yields, Jones says.
"We're moving in the right direction, but it's a slow process," she says.
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