We expect the U.S. economy to grow between 2% and 2.5% over the next year, and that the Fed may continue to raise interest rates. We believe the moves will occur at a slower pace than in the past, however, and that the magnitude of any tightening will depend on the factors that the Fed has been monitoring, such as employment, inflation, dollar strength, oil prices, and financial market volatility.
The role of the dollar
The U.S. dollar’s performance will be an important determinant of policy. Capital has flowed into the United States because of the relative strength of its economic recovery, causing the dollar to appreciate, which has a similar effect as monetary policy tightening. For example, a strong currency holds down import prices and keeps a lid on inflation — so ongoing strength in the dollar would accomplish some of the tightening for the Fed. On the other hand, if the dollar does not appreciate much, the Fed will have a bigger job to do.
In our view, investors get paid to take on four types of fixed-income risk: interest-rate risk, credit risk, cash flow uncertainty, or “prepayment risk,” and liquidity risk. We expect to emphasize credit, prepayment, and liquidity risk and de-emphasize interest-rate risk in the quarters ahead. In our opinion, the so-called “spread sectors,” from high-yield bonds to non-agency mortgages and emerging-market debt (EMD), currently offer attractive levels of credit, prepayment, and liquidity risks, particularly for investors who know how to analyze these risks.
We expect to continue to focus on commercial mortgages and non-agency residential mortgages, because in our opinion, investor compensation is attractive in these sectors. In our commercial mortgage-backed securities (CMBS) allocations, for example, we will continue to concentrate on mezzanine CMBS, a tranche that reflects the middle range of a multi-class security and is considered to be in the mid-range of that security’s overall credit risk. 299287
For informational purposes only. Not an investment recommendation.
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Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.
