Global Uncertainties Dampen Long Rates

• GDP
• Unemployment
• Interest Rates
• Inflation
• Business Spending
• Energy
• Housing
• Retail Sales
• Trade Deficit

Long-term interest rates are declining a bit, but short-term rates are not, flattening the yield curve. This week, the rate difference between the 10-year bond and the one-month bill fell below a percentage point, after last month crossing the line for the first time since early 2008. Concerns about an escalating trade war are dampening the long end some, and pension funds are buying a lot of 30-year bonds because of an expiring tax break on September 15. Ramped up Treasury Dept. borrowing is also oversupplying the short-end market, which, coupled with the Federal Reserve’s cutback in purchases, is keeping short rates from falling.

Some fear that an inversion of the yield curve is imminent, signaling recession. The yield curve becomes inverted when short-term rates are higher than long-term, which historically indicates an economic slowdown is on the horizon within 12 months. In 2007 the Fed hiked short rates to combat inflation while the longer-term economic outlook became cloudy, depressing the long end, leading to the Great Recession.

However, today’s flattening is more technical. The Fed’s normalization program requires lifting the short end first as it raises the federal funds’ rate and cuts back securities purchases. The federal government could also issue more long-term bonds for its borrowing needs. Finally, trade wars can end as quickly as they begin, although this one has the potential to snowball.

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Long-term rates will move up, despite short-term volatility. The global stock market’s recent hiccups stem from worries over the trade war between the U.S. and most the rest of the world, causing investors to seek bonds’ safety, dropping rates. But rising government deficits amid an expanding economy with slightly higher inflation should keep the market heading upward.

The Federal Reserve is committed to raising short-term rates this year and next because it’s concerned about the tightening labor market. The Fed very much wants to stay ahead of any inflation that rising wages may generate and will lift short-term rates by a quarter of a percentage point twice more this year after doing so in June. That would put the federal funds’ rate at 2.5% heading into 2019, when another three increases are expected.

We think today’s 2.9% yield on the 10-year Treasury note will hit 3.2% by year-end. The bank prime rate that auto loans and home equity loans are based on will bump up from 5% to 5.5%. The 30-year fixed-rate mortgage is likely to go up to 4.8%, and the 15-year fixed-rate mortgage should rise to 4.3%.

Higher interest rates are finally coming to savers. Although big banks have been slow to reward savers, rates on money market accounts and CDs at smaller banks, credit unions and online banks have picked up to nearly match rates on Treasury bills and notes.

Source: Federal Reserve Open Market Committee

See Also: America’s Yield Curve Panic Is Overdone