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With Fed's Mission Accomplished, Expect Rate Hikes And Low Bond Returns

With the U.S. Bureau of Labor Statistics on Friday reporting that a strong number of new jobs were created in February, the Federal Reserve has accomplished its mission of keeping inflation low while promoting economic growth.  Investors for the foreseeable future should expect periodic rate hikes and low returns on bonds.

The news on Friday that the economy had created 235,000 and that the unemployment rate had fallen to 4.7% came a week after the Federal Reserve Chair Janet Yellen said that, unless some unexpected bad news were to occur, a rate hike was likely in March.

With job growth strong and unemployment about as low as it's been in a decade, it's likely the Fed will follow through on a plan Ms. Yellen outlined in a speech on March 3 in Chicago.  In her speech before The Executives' Club of Chicago, Ms. Yellen said she expects the Fed Funds rate over the next few years would revert toward its "neutral" rate of 1%, which is "neither expansionary nor contractionary when the economy is operating near its potential."  Adding an inflation rate of 2% to the Fed Funds rate would mean the Fed is targeting a 3% Fed Funds rate over the next several years.

"Gradual increases in the federal funds rate will likely be appropriate in the months and years ahead," said Ms. Yellen.  "Those increases would keep the economy from significantly overheating, thereby sustaining the expansion and maintaining price stability."

For fixed-income investors, it's wise to expect low returns on bonds in the period ahead.  The Fed raised rates once in 2015 by one-quarter of 1% and by the same amount again in 2016.  With the economy continuing to show signs of expansion, more rate hikes should be expected for 2017.  Fixed-income investors have had to settle for lower returns in recent months, but they should be prepared for even lower returns ahead as bond prices are expected to drop.

It was an uneventful week for stocks, and the six-week winning streak for the Standard & Poor's 500 index was snapped, as the index closed the week at 2,372.60, just slightly off from its recent all-time high.

While the stock market paused, it rose nearly 12% in the three months since the presidential election, and last week marked the bull market's eighth anniversary.  Stock prices have soared because economic signals are positive, but also because investors have begun to expect a tax break to be enacted by Congress.  With political intrigue dominating headlines recently, however, an enactment of health care legislation as well as reform of tax laws in limbo, a correction of 10% or 15% is possible at any time.  If politics get in the way of cutting taxes and writing a new health care law, the stock market could be vulnerable.

With fake news and alternative facts flourishing, our weekly reports are not intended as advice but as a source of prudent analysis about news affecting your wealth over the long run.  Please feel free to share them with your family and friends.

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