The increase in rates since the U.S. Election has shattered the previous notion that we had re-entered a 'lower for longer' interest rate environment. Transamerica’s Tom Wald shares his thoughts on where interest rates are heading...
Since the surprise election of Donald Trump two weeks ago, interest rates have taken a sharp upward turn. Perhaps best exemplifying this is the yield on the 10-year Treasury, which has now exceeded 2.30%, rising more than .50% since Election Day and .95% from last July when it fell to an all-time low of 1.37% in the immediate aftermath of Brexit.
Market reactions were likely based on what the media are referring to as Trumponomics: Legislation and policy based on lower corporate and personal taxes, overseas tax repatriation, higher levels of infrastructure spending and less financial regulation. And to initially finance such policy, it is also widely believed that U.S. debt and federal deficits could increase, at least until higher levels of growth in the economy are achieved.
This all equates to higher interest rates, which is certainly what we have seen in the days since the election. With this in mind, here are some of our thoughts looking forward.
Our thinking is that the Fed will raise the Fed Funds rate at its December meeting by a quarter point. More rate hikes are likely to follow throughout 2017.
The Fed now essentially has 'cover' it did not have before the election regarding the market effects of increasing rates. It has been our feeling that ever since its lone rate hike of December 2015, and the stock market correction that immediately ensued during January and February, the Fed has been reluctant to hike rates for fear of negatively impacting the equity markets. Now they no longer have to worry about that.
Since the stock market has rallied over these past few weeks, and the Dow Jones and S&P 500 have reached record levels, the Fed will likely downplay its 'data dependent' persona and use the next several months as an opportunity to catch up on the lost time during 2016.
Turning the clock back
In some ways it's almost as if we are right back where were a year ago – a December rate hike with expectations of perhaps three or four to follow in the year ahead. (The only difference of course being that a full year has passed, the Cubs have won their first World Series in 108 years and Donald Trump is now president).
Fiscal policy, the means by which government adjusts its spending levels and tax rates to monitor and influence the nation's economy, will now play a much larger role in the expectation of interest rates than it has since the early days of 2009. For more than seven years the U.S. economy has been highly dependent on monetary policy only, and this change we believe will help to push rates higher in the year ahead.
There could be a case of pent up demand in the economy during the year ahead stemming from increasing wage growth, higher personal savings, and stronger consumer spending. Should these trends result in higher levels of GDP growth, perhaps close to 3% as appears may have been the case in 3Q based on its initial estimate, then further rationale will fall into place for higher rates.
Finally, a word of caution that all of this having been said, rates have moved very far and very fast, reflecting that much of this has been taken into account. For this reason, we likely see rates as range-bound within about .25% of current levels (about 2.30% on the 10-year Treasury) between now and the New Year. However the playing field has clearly changed as all eyes are now fixating higher than they were just a few weeks ago.
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