In its Federal Open Market Committee meeting last week, the Federal Reserve maintained its commitment not to raise rates for "a considerable time" after it concludes its asset purchase program in October 2014.
Importantly, the Fed did not change its policy guidance to conform to any specific "data-based" metrics, such as unemployment. Nevertheless, we sense the Fed remains sensitive to unemployment and that it does not want to send any messages about higher rates until the economy is on a more solid footing and capable of sustaining such higher rates.
That said, it is also interesting to note how the quantity and quality of forward rate guidance from the Fed has improved following the September 17 meeting and the degree to which such forward guidance appears to be creeping up, albeit gradually, from prior meetings.
Compared to previous FOMC meetings, the September 17 meeting provided some new guidance that is worthy of discussion. First, the median target rate for fed funds at year-end 2015 has risen by 25 basis points (bps; note: 100 bps equal one percentage point) to 1.375% from 1.125%.
Second, the Fed established a target rate for Fed funds during 2017. Previously the 2017 rate was included in its longer-term rate guidance. In this case, however, the 2017 median rate of 3.75% is in-line with the 3.875% longer-term rate the Fed anticipates going forward. Based on the data provided, we believe that interest rates are most likely going to begin rising between mid-year 2015 and late 2017.
Although the current guidance (based on the statistical median of the 17 FOMC voting members who expressed an opinion on the Fed funds rate) is somewhat higher than the 3.0% rate previously anticipated, the time-frame for the tightening appears to be sufficiently long in order to reduce the negative impact that a more sudden change in rates could have on the markets.
Based on the commodities futures market, the forward yield for the 10-year Treasury is expected to be 3.309% in September 2015; while 90-day Euro Dollar Deposits (3-month LIBOR) is expected to be at 3.00% in December 2017 and 4.00% in December 2022.
While these rates are somewhat below the forward guidance proffered, as investors have been whipsawed by previous guidance, we still believe that the Fed is attempting to guide future rate expectations to the higher end in an effort to help temper future interest-rate shock, and to spur investors and consumers into action.
Such action could be in the form of new investment for property and plant or for new purchases of merchandise in the expectation that economic growth continues to improve.
What Should Fixed-Income Investors Do?

In our Fixed Income Strategy Weekly of September 6, 2014, "Investors Demand Income," we said that we were anticipating higher short-term rates in 2015. Although higher short-term rates would be a benefit to those investors who remained on the sidelines, other investors may be hurt by higher interest rates. In particular, those investors that are heavily weighted in very long-term bonds and/or credit-sensitive securities, such as high-yield bonds and/or senior secured bank loans, may be in for a very rude awakening as these instruments are likely to react poorly to higher rates.
In our opinion, investors should take this opportunity to reexamine their portfolios to ensure that it is adequately diversified, and that the portfolio is in line with the investor's overall risk tolerance and investment objectives.
Bond investors should concern themselves with several types of risk. Credit risk is the risk that a bond may default before its final maturity. This risk can be partially mitigated by carefully examining the bond's credit ratings. However, another measure of risk is duration risk, the sensitivity of a bond's price to a change in interest rate movements. As an example, the price of a bond with a duration of five years would be expected to rise or fall 5% in price for every one percentage point change in market interest rates. The longer (higher) the duration, the more its price will fluctuate as interest rates rise and fall.
To increase the diversification of a fixed-income portfolio, we believe that investors should also think "outside" of the traditional fixed-income area by investing in alternative income vehicles such as equity property REITs (real estate investment trusts), BDCs (business development companies), and other higher yielding equity securities.
McCluskey is senior fixed-income strategist with Wells Fargo Advisors, the brokerage unit of Wells Fargo & Co.