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Economic Forecasts

Higher Interest Rates Likely Permanent

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 2.5% 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 $40 to $45 per barrel in Dec. 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 »

The recent step-up in interest rates is likely to be permanent. The 10-year Treasury bond rate jumped from 1.8% to 2.1% the day after the election, in anticipation that Donald Trump’s policy proposals would cause significantly higher government budget deficits, and that he would likely appoint more-hawkish Federal Reserve Board members who favor raising rates sooner. Congress is likely to trim Trump’s wish list considerably, but uncertainty as to what will ultimately pass will persist for some time to come. In fact, this Trump premium in rates is likely to persist throughout his presidency.

The Federal Reserve is still on track to raise short-term interest rates a quarter of a percentage point on December 14. Decent employment reports for August, September, October and, presumably, 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 would hold fire is a meltdown in the financial markets, but that does not appear likely now.

See Also: All Our Economic Outlooks

Expect interest rates to rise gradually after December 14. They will be more volatile now, as fears about the deficit wax and wane. But unless those concerns deepen considerably, rates should show only a modest uptrend. Only when inflation appears stronger, or when the Fed commits itself to getting the federal funds rate up to a more “normal” level of 3%, will rates mount a sustained and steady rise. With Trump’s plans still taking shape, the 10-year Treasury bond rate is likely to end 2016 around its current value of 2.1%, because the Treasuries market has already priced in the Fed’s first hike in a year.

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In 2017, figure on only one or two Fed rate hikes, because economic growth is likely to be a bit soft. 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 some time. Since 41% of its portfolio is in mortgage-backed securities, delaying the move to end the replacement practice should keep mortgage rates from rising too much.

By the end of 2017, we see the 10-year Treasury note yielding 2.5%. Expect the average 30-year fixed rate mortgage to edge up to 4.3%, with 15-year fixed rates at 3.6%.

Source: Federal Reserve, Open Market Committee