Will firms' March inflation forecasts impact the Fed’s mandate? (Part 5 of 5)
Interest rate forecast
The results of the Atlanta Fed’s Business Inflation Expectations (or BEI) survey primarily help in determining whether interest rates are expected to increase or decrease. Other things remaining constant, an increase in inflation expectations leads to an increase in interest rates and fall in bond prices, and vice versa.
Judging by this month’s survey results, it would appear that both price and cost inflation are edging downwards. Firms have indicated that sales levels are much the same as last year. This would imply, other factors remaining constant, in the face of stagnant or declining sales, businesses will be reluctant to increase prices in the near term. This would ease price-related inflationary pressures.
At the Fed’s recently concluded FOMC meeting last week, the Fed indicated that it would link the increase in the Fed funds rate to a wide range of information, including labor market releases, inflation expectations, and financial market indicators. The Fed also indicated that it would look at raising the rate a few months after the end of monthly asset purchases. This is expected to be between Q2 and Q4 2015.
Looking at the BEI survey from March, this could be at the tail end of 2015, as inflation still shows no signs of edging up. In fact, looking at the unit costs data for March, inflation actually declined. Lower inflation is likely to keep interest rates low and bond prices higher, other factors remaining constant. This would benefit fixed income ETFs overall, including the iShares 10–20 Year Treasury Bond ETF (TLH) and the iShares 20+ Year Treasury Bond ETF (TLT). An ETF with exposure to the corporate bond market is the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD). The Core Total U.S. Bond Market ETF (AGG) provides exposure to both government and corporate bonds in the U.S. that are rated investment-grade and with maturities of more than one year.
On the other hand, should inflation increase faster than expected, the natural resources (IGE) and precious metals (GDX) sectors are good hedges against any erosion of investment returns due to inflation.
To learn more about investing in fixed income securities, see Market Realist’s Fixed Income ETFs page.
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