What is going on with interest rates? Over the past several weeks we have experienced sharp up-ticks in interest rates that have not been seen since 2008, right before the Great Recession. Both short term rates (the Federal Funds rate) and longer-term rates (the 10-year Treasury bond) are on the rise. Why have rates increased so significantly over just the past several weeks, mainly, since Donald Trump was elected president?
First, short-term rates (the Federal Funds rate) have been on the rise mainly because Federal Reserve Chairwoman Janet Yellen and the Fed want to keep the economy in the ‘sweet spot’: keeping inflation under wraps and preventing the economy from over-heating. Some would contend that the economy is still in recovery mode since the Great Recession, but that’s not how the monetary policy hawks at the central bank see it.
Yellen and company just increased rates for the second time in 2016 through the Federal Funds rate. This rate was increased by 0.25% on December 14th, with the Fed citing the steady growth of employment and other economic factors as justification. It is interesting to note that this decision to raise rates was made by a unanimous vote of all 10 members of the Federal Open Market Committee, the first time in recent months that the Fed has acted by consensus. Many analysts expect another three 0.25% increases in short-term rates come 2017. Yellen stated at a news conference after the announcement:
“My colleagues and I are recognizing the considerable progress the economy has made. We expect the economy will continue to perform well.”
Second, longer-term rates (longer-term bonds such as the 10-year bond) have been on the rise mainly in response to President Donald Trump’s proposed economic and fiscal policies. Trump has let it be known that he wants to spend in the area of $500 billion on infrastructure programs like building roads and bridge. He has also proposed significant tax cuts (mainly for the wealthy) to help stimulate the economy. Both of these agendas are intended to spur economic growth significantly, which the bond markets have viewed as inflationary in the future. Stronger future economic growth and resulting inflation would need to be cooled by higher interest rates. This is why interest rates on longer-term bonds have increased so dramatically over the last few weeks.
By longer-term rates, we are referring mainly to the yield on the US 10-Year Treasury bond. These bonds are now yielding in the area of 2.5%, a yield they have not reached since September 2014. Yields were hovering around 1.8% a month ago, after reaching a record low of 1.34% back in July. Many experts think that yields will be above 3% before long. If rates do go a lot higher, it would impact how much interest consumers would have to pay for mortgages, credit cards and a variety of other types of loans. For example, mortgage rates, which follow the 10-year Treasury bond, have increased to 4.30% from 3.50% earlier this summer. A 0.50% increase in mortgage rates can make a difference of a couple hundred dollars in monthly mortgage payments.
One of my favorite investment and economic gurus who has been right more often than wrong over the last few years is Jeffrey Gundlach of Doubleline Capital. Maybe a little on the high side, Mr. Gundlach has reasoned that bond yields could rise to a lofty 6% within the next few years if Trumps fiscal and economic policies are enacted.
In the attached video from Bloomberg, “Trump Means Fast Adjustment to Higher Rates”, Larry Hatheway, head of investment solutions at GAM Group, and Richard Turnill, at BlackRock Investment Instititute, discuss interest rate expectations under the economic plan of US President Elect Donald Trump. Both men agree that interest rates will quickly adjust upwards. The two guests cite increased borrowing and fiscal spending, increasing global economic growth, rising wages and a fully-employed labor force where inflation is beginning to materialize as evidence of the need for higher rates. Mr. Turnill goes on to justify his belief that the 30-year bull market in bonds has finally come to an end.