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Economic Forecasts

Short Rates Up, Long Rates Not

Kiplinger's latest forecast on interest rates.

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GDP 2.1% growth in ’17, following 1.6% in ’16 More »
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Interest rates 10-year T-notes at 2.4% by end '17 More »
Inflation 1.6% in '17, down from 2.1% in '16 More »
Business spending Rising 3%-4% in ’17, after flat ’16 More »
Energy Crude trading from $40 to $45 per barrel in September More »
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The expectations of the Fed and bond investors are at odds, which is flattening the yield curve: Short-term rates, such as the prime rate, are rising, but long-term rates, such as mortgages, are not. This state of affairs is likely to last for a while.

Bond market investors see falling inflation caused by the drop in crude oil prices, as well as subsiding price pressure on new and used cars, doctors’ services, food and clothing. Oil prices particularly will likely remain low. 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. The Fed appears committed to a path of steady rate hikes. It will probably lift short-term rates by a quarter of a percentage point once more in 2017, likely at its meeting on December 13.

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But, the Fed may need to dial back. Its monetary policy committee (the FOMC) plans three, quarter-point increases in 2018 and three for 2019, bringing the federal funds rate to its preferred 3% level if the economy keeps growing as expected. We think this may be ambitious amid low inflation and slow growth.

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At either its September or December meeting, the Fed will begin gradually not replacing maturing securities in its $4.5-trillion portfolio. This policy change and the expected rate hike are likely to boost long-term rates a little.

We think the yield on the 10-year Treasury note will hit 2.4% by the end of 2017, up from 2.15%. The bank prime rate will bump up to 4.5% from 4.25%.

By year’s end, expect the average 30-year fixed mortgage rate to rise to 4.1% from 3.9%, with 15-year fixed mortgage rates reaching 3.4%, versus 3.2% now.

Source: Federal Reserve, Open Market Committee

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