Why is a boxing ring called a ring when it’s shaped like a square? Because back in the day, boxers would fight in a circle roughly drawn on the ground. They faced off in circular rings until the square ring was introduced in the 1800s. To this day, the boxing ring is sometimes referred to as the "square circle."
Southpaw or Orthodox?
In some sense, the Federal Reserve (Fed) is in a ring of its own. With most of the world’s central banks on the side of easing, the Fed is making the diametric move of raising its benchmark interest-rate target to between 0.25% and 0.50%. This step forward in normalizing monetary policy is said to be the first in a series, and the pace of future increases is promised to be gradual and would go alongside a growing U.S. economy. The inflation outlook is another key consideration for the timing of the next increase.
Roll With the Punches
Divergence in central bank policies remains an important investment theme going into 2016. But keep in mind central banks will not provide the same level of market support for asset prices that they have in recent years. Case in point: the European Central Bank’s (ECB’s) much-signaled but slighter-than-expected quantitative easing (QE) upgrade. In fact, the market reaction again shows that conditions outside the United States can drive, or even dominate, U.S. markets. We have already seen the impact of low European rates on the U.S. yield curve and rising volatility driven by China and the collapse in oil prices this year. What’s next?
Go the Distance
We are prepared for more Fed rate hikes next year and are staying with our regimen: a portfolio tilted toward stocks, select credit and tax-exempt bonds. We see interest rates rising but expect them to climb slowly and remain low for a long time. Should policy divergence result in a stronger U.S. dollar, stocks stateside could be put under additional pressure. Our emphasis is on opportunities abroad (like Europe), and sectors (e.g., financials) that could withstand, or even benefit, from a rising rate environment.