Vanguard's Joe Davis on interest rates, the US economy and what the Federal Reserve will do next

Plus, the global chief economist and head of the Vanguard Investment Strategy Group discusses whether federal debt is at crisis levels.
MAR 23, 2017

Joe Davis is Vanguard's global chief economist and head of the Vanguard Investment Strategy Group, which helps set the Valley Forge, Pa., fund behemoth's asset allocation strategy. Mr. Davis spoke with InvestmentNews about the outlook for interest rates, the economy and the Federal Reserve's next actions. InvestmentNews: What's your outlook for the 10-year Treasury note? Joe Davis: We haven't changed our outlook in the past couple years. We're looking at 2.5% on the 10-year Treasury. We did anticipate modest rises in short-term rates, given Federal Reserve policy, but that doesn't mean long-term interest rates will rise. And it's not just our cyclical view on the economy. There are long-term forces that drive the 10-year rate as well. I personally would be shocked if the 10-year got to 4% over the next decade. We tend to look over all periods of time, and we're able to collect data for two centuries. What we've found is that the 70s and 80s were the outliers rather than the norm. Without that period, the average for the 10-year T-note has been closer to 3%. There would have to be a fundamental change of inflation drivers. IN: So where are we in the economic cycle? JD: I think we're right about midway. I don't think a recession is imminent, some unfortunate event aside. On structural basis there could be problems with government debt levels, but the rest of the economy, from autos to construction, is in decent shape. The greatest risk is from overseas: The U.S. economy is likely to remain resilient. IN: Some economists say that the Fed is likely to let the economy run hot for a while — in other words, err on the side of increased growth and inflation. Do you think inflation is a danger? JD: I don't think the economy will run hot. I'm more gratified to see the more pernicious deflationary forces moderate, whether it's in commodities or excess manufacturing capacity. The Fed wants to see 2% core inflation, and that's likely to occur. But (Fed chairwoman Janet) Yellen threw cold water on the notion of letting the economy run hot: She used the word "unwise" in her speech in February — that was a clear shot across the bow. We think there's a high probability the Fed will raise rates in June, and that there will be two hikes this year. That will still leave the fed funds rate below 2%. We'll see more deliberations about tapering the size of the Fed's balance sheet, which keeps rates low. The Fed will (and should) tread lightly with regard to tapering the balance sheet. They are going to be cautious and deliberate in how they do this, likely by reinvesting less. We could see talk about that as early as the economic symposium at Jackson Hole. IN: Essentially, you're calling for a flatter yield curve. That's not great for banks. JD: I think we will continue to see a flattening of the yield curve. It won't invert. Ironically, at the margin, that outlook means there's more risk in near-term bonds. IN: So you're not recommending buying short-term bonds. How about credit quality? JD: You want some Treasuries in case there's a flight to quality. We also like high-quality corporate bonds and high-quality overseas bonds on a hedged basis. We have modest expectations. We don't expect outsized returns. We're reluctant to have too much exposure to high yield at these levels. So we're more inclined to match duration to credit exposure. IN: Does the size of the federal debt concern you? JD: It has not been in my top five list of worries. Longer-term, debt is the seminal economic political and social issue of our lifetime. It's not sustainable. But for it to be a crisis now we'd need to see investors demand a higher risk premium, i.e., yield. And we'd need to see a viable alternative bond market and reserve currency.

Latest News

MassMutual Ascend tops $2 billion in RIA annuity sales as advisors warm to income products
MassMutual Ascend tops $2 billion in RIA annuity sales as advisors warm to income products

Ten years after entering the fee-based annuity market, MassMutual Ascend says nearly half its lifetime sales came in the past two years alone – but barriers remain among fee-only advisors.

Fintech bytes: Wealth tech firms target advisor productivity with new integrations
Fintech bytes: Wealth tech firms target advisor productivity with new integrations

Amplify, WealthReach, Zeplyn and Zocks have unveiled partnerships aimed at automating portfolio management, content creation, account opening, and client communication.

Trump Account contributions to get boost from new employer rules
Trump Account contributions to get boost from new employer rules

New Treasury and IRS proposals would let employers add tax-free payroll contributions to the retirement accounts as advisors weigh the fit for client families.

Merit Financial snaps up $900M Bridgeway Group in California push
Merit Financial snaps up $900M Bridgeway Group in California push

The Atlanta-based RIA has now completed nine acquisitions in 2026, with six of those coming from Commonwealth Financial Network's former advisor base.

Generational wealth strategies are shifting as families and business owners eye Trump Accounts
Generational wealth strategies are shifting as families and business owners eye Trump Accounts

Half of small business owners want their company's success to fund generational wealth, says Guardian Life research.

SPONSORED Direct indexing webinar targets tax-loss harvesting amid market swings

Northern Trust’s Ken Lassner shows advisors how to convert volatility into after-tax portfolio gains

SPONSORED Who builds the income when the pension disappears?

Dan Biagini of American Equity says the steady decline of pensions, longer lifespans and a reset in interest rates are rewriting how advisors build retirement income