At their January monetary policy meeting, Federal Open Market Committee members said target interest rates will remain near-zero at least until late 2014, nearly a year later than previously announced. The Committee also included tables detailing individual policymakers’ expectations for rates providing an unprecedented level of transparency to investors.

We recently sat down with Capital Group Private Client Services fixed-income portfolio manager John Queen to get his reaction to the new outlook and to find out what it might mean for client portfolios.

The latest release from the Fed shows clarity regarding where interest rates are headed. What message is Federal Reserve Chairman Ben Bernanke sending to the market?

Bernanke’s message is consistent with the message he’s been giving from the beginning, which is his belief that the central bank will be more effective at meeting its dual mandate of full employment and stable inflation if the market has a better understanding of what the Fed is doing. By showing Committee members’ individual outlooks for interest rates, the Fed created another tool to provide guidance. The danger of being too transparent is eventually, the Fed will have to adjust its view. The inclusion of individual perspectives allows the central bank to subtly show that these are just outlooks and likely to change over time as members’ views of the economy change well before the Fed actually changes the target date for a rate increase.  

How does the Fed’s decision to keep interest rates at record lows for nearly three more years affect your expectations for the U.S. recovery? 

The Fed continues to see an environment of slow, but sustained growth, although the rate of expansion is sluggish enough that it won’t quickly bring down the unemployment rate. Inflation—the second part of the dual mandate—remains subdued, which means the central bank can continue to look for ways to stimulate the economy. The decision to reinforce expectations that rates will stay low for a long time is a way to encourage people to shift from cash into riskier assets.

What are the pros and cons of having a low-rate environment for such a long time?

These are very good conditions for slightly higher-risk bonds—and I don’t mean high-yield bonds, but rather non-Treasury bonds. Mortgages tend to do well in a scenario where there’s little question as to where interest rates are headed. Having a very stable low-rate environment is also good for corporations because financing becomes more predictable. It’s easier for them to have a clear sense of how much it will cost them to raise money.

On the opposite end, these conditions are difficult for people with a shorter timeline who rely on income from short-term bonds or savings. But again, the Fed’s move was designed to push people into riskier assets.

How does the Fed’s new outlook affect portfolio positioning?

We’re not making any significant changes to portfolios. This is just a change in one particular piece of the larger picture that we consider when making investment decisions. There are still lots of other issues to deal with. For me, this new outlook reinforces my view that we shouldn’t dramatically reduce durations of fixed-income securities.

If returns on bonds are expected to be weak for a while, are fixed-income securities still important components of portfolios?

Well, there’s no such thing as a free lunch. Bond yields incorporate both the real return requirements of investors (how much they are willing to pay and get in return for that level of safety), but they also incorporate the market’s inflation expectations. Yes, yields are low in an absolute sense, they have been for a long time and they can stay low for a while. But bonds aren’t bad investments just because they carry low yields. Bonds' relative safety and liquidity are highly valued in the market because there’s still a lot of uncertainty out there. If you knew where the market was headed, you wouldn’t need a diversified portfolio. Bonds will continue to do what they’re supposed to do: provide a low-risk, low-return for the portfolio while offering protection from volatility in equities. n