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Economic Forecasts

Fears of Future Inflation Cause Rates to Rise

Kiplinger's latest forecast on interest rates

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GDP 1.5% growth for the year; a 2.1% pace in '17 More »
Jobs Hiring at 150K-200K/month through '16 More »
Interest rates 10-year T-notes at 2.7% by end '17 More »
Inflation 2.0% for '16, 2.4% in '17 More »
Business spending Slight gain in '17 after flat '16 More »
Energy Crude oil trading from $50 to $55 per barrel in March More »
Housing Single-family starts up 9% in '16, 11% in '17 More »
Retail sales Growing 3.7% in '17 (excluding gas) More »
Trade deficit Widening 4% in '17, matching increase in '16 More »

Interest rates are headed up because bond investors are seeing more signs of coming inflation. Rates rose last week because investors think OPEC’s agreement to cut production will lead to higher oil prices, which in turn will boost inflation. Likewise, the rate jump that followed the presidential election was the result of anticipation that Donald Trump’s policy proposals will cause significantly higher government budget deficits, which is also inflationary.

We think the yield on the 10-year Treasury note will hit at least 2.7% by the end of 2017, up from 2.4% currently. While there is considerable uncertainty about the OPEC agreement and the ultimate size of Trump’s fiscal stimulus, it looks as if the trend in rates will be upward in the near term. Still, rates should flatten out eventually, because economic growth in 2017 is likely to be less than many investors are expecting.

See Also: All Our Economic Outlooks

The Federal Reserve is still on track to raise interest rates on December 14. Decent employment reports for August, September, October and November should give the Fed the cover to act. Wages are now growing at a 2.8% annual rate, which also indicates a tightening labor market. The only reason the Fed will hold fire is if it is concerned about the tightening effect of the rate rise on longer-term securities.

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In 2017, figure on just one or two Fed rate hikes because economic growth will be only moderate. There may be some downward pressure on interest rates in the early part of the year as concerns about Britain’s looming departure from the European Union take center stage once again. However, this is likely to be temporary. Rising U.S. wages will cause inflation expectations to rise a tad, strengthening the Fed’s case for slightly higher interest rates.

Look for the Fed to keep replacing maturing securities in its $4.5-trillion portfolio for now. But eventually, they will need to end the practice. And since 41% of the Fed’s portfolio is in mortgage-backed securities, that could cause a bump-up in mortgage rates.

By the end of 2017, expect the average 30-year fixed rate mortgage to rise to 4.5%, with 15-year fixed rates at 3.8%.

Source: Federal Reserve, Open Market Committee