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Economic Forecasts

Fed Will Raise Rates in First Half of 2017

Kiplinger's latest forecast on interest rates

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The Federal Reserve has more or less promised to make its next quarter-point rate hike by midyear. The minutes of the Federal Open Market Committee in January noted that “many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon” if data on the labor market and inflation continue to indicate strength. Janet Yellen, in recent testimony to Congress, said “waiting too long…would be unwise.”

It seems unlikely that the Fed will boost the rate as early as their meeting on March 15, unless the February employment and inflation reports are strong. But some on the committee are arguing for moving sooner rather than later, saying they want the flexibility to cut rates later if the economy slows unexpectedly.

The Fed could hike short-term rates two or three times in 2017, but it wants to raise them gradually to avoid dampening economic growth. In fact, it doesn’t expect to reach its preferred level of 3 percent for short-term rates until sometime in 2020. And the expected inflationary effects of President Trump’s proposed tax cuts and spending on the military and infrastructure will be mostly pushed into 2018, so the Fed does not expect to have to hike rates aggressively this year to rein in inflation.

See Also: All Our Economic Outlooks

Overall, interest rates jumped after the presidential election because of the prospects for higher deficits and higher inflation, spurred by Trump’s tax and spending proposals. But considerable uncertainty exists over how much of his program will be adopted, when it will be adopted and how it will be paid for. This has caused the 10-year Treasury rate to meander up and down so far this year. However, it is highly likely that sometime in 2017, it will become clear to bond markets that both the deficit and inflation are headed higher.

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We think the yield on the 10-year Treasury note will hit at least 3% by the end of 2017, up from 2.4% currently. While there is considerable uncertainty about how much inflation will pick up due to higher energy prices and the ultimate economic impact of Trump spending policies, the trend in rates will be upward in the near term.

Look for the Fed to keep replacing maturing securities in its $4.5-trillion portfolio for the foreseeable future. But eventually, it will need to end the practice. Since 41% of the Fed’s portfolio is in mortgage-backed securities, that could cause a bump up in mortgage rates when the course is reversed.

By the end of 2017, expect the average 30-year fixed-rate mortgage to rise to 4.6%, with 15-year fixed mortgage rates at 3.8%.

Source: Federal Reserve, Open Market Committee