Long Rates to Stay Low
|GDP||2.1% pace in '17, 2.4% in '18|
|JOBS||Hiring pace should slow to 175K/month by end '17|
|INTEREST RATES||10-year T-notes at 2.4% by end '17|
|INFLATION||1.4% in '17, down from 2.1% in '16|
|BUSINESS SPENDING||Rising 3%-4% in '17, after flat '16|
|ENERGY||Crude trading from $40 to $45 per barrel in December|
|HOUSING||Existing-home sales up 3.5% in '17|
|RETAIL SALES||Growing 3.5% in '17 (excluding gas)|
|TRADE DEFICIT||Widening 4% in '17, after nearly flat '16|
Long-term interest rates should rise a small amount by the end of the year, but the lack of pickup in inflation, and continuing economic and fiscal policy uncertainties will likely limit the increase. This should still be the case even when the Federal Reserve raises short-term rates or limits its securities purchases.
Bond market investors see tepid inflation caused by flat crude oil prices, as well as subsiding price pressure on new and used cars, doctor visits, food and clothing. Investors also believe that any bump to economic growth from government fiscal policies will be delayed.
The Fed, on the other hand, sees low inflation as temporary and is focused on the falling unemployment rate and other indicators that show a tightening labor market. The Fed very much wants to stay ahead of any inflation that rising wages may generate, and will probably lift short-term rates by a quarter of a percentage point once more in 2017, likely at its meeting on December 13.
But the Fed may need to dial back in 2018. Its monetary policy committee, the FOMC, plans three, quarter-point increases in 2018. We think this may be ambitious amid low inflation and slow growth.
Likely at its September meeting, the Fed will begin winnowing its $4.5-trillion securities portfolio. This policy change and the expected rate hike are likely to boost long-term rates only a little.
We think the yield on the 10-year Treasury note will hit 2.4% by the end of 2017, up from 2.3% now. The bank prime rate will bump up to 4.5% from 4.25%. By year’s end, expect the average 30-year fixed-rate mortgage to rise to 4.1% from 3.9%, with 15-year fixed-mortgage rates reaching 3.4% versus 3.2% now.