Interest Rates: Will Higher Inflation Spike Long Rates?
Kiplinger’s latest forecast on interest rates
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Investors in long-term bonds appear to be serene at the moment, but higher inflation numbers are coming. As the economy has strengthened, shortages have developed, pushing up prices of cars, appliances, car rentals, housing, etc. Government stimulus packages and possibly even more spending on infrastructure and other priorities will keep the economy running hot and apply upward pressure on yields on 10-year Treasury notes. 10-year yields have risen three-quarters of a percentage point since the beginning of the year. Expectations are that U.S. government debt will rise to 108% of GDP this year, and 114% next year if more spending legislation is passed. This is uncharted territory: The highest U.S. debt has ever been was 106% of GDP right after World War II. Expect the 10-year yield to rise to at least 2% by the end of the year.
The rise in the 10-year rate will also push up mortgage rates, from 3.0% currently to 3.5% by the end of the year. Rates on long-term car loans should also bump up.
Chair Jerome Powell of the Federal Reserve has said that the Fed would consider any spike up in inflation this year to be temporary. That means that the Fed will not raise short-term rates, even if inflation picks up. It remains focused on its goal of seeing a lower unemployment rate and a recovery in the labor market.
Short-term consumer loan rates such as home equity lines of credit will stay where they are. These tend to be tied to the federal funds interest rate, which is controlled by the Federal Reserve. It’ll be held constant for an extended period of time.
While the Federal Reserve is committed to keeping short-term interest rates near zero for a while, watch for signs that it may begin tapering its purchases of Treasuries and other securities. The Fed is purchasing $80 billion of Treasury securities and $40 billion of mortgage-backed securities every month, adding to its balance sheet. When the Fed thinks the economy does not need this support, it will begin reducing its purchases by $10 billion of Treasuries and $5 billion of MBS’s every six weeks at its FOMC meetings. This will take place before the Fed raises short-term rates, since it is considered to be an intermediate measure.
Corporate high-yield bond rates are declining, as the strong economy is outweighing any inflation concerns. CCC-rated bond yields are down to 7.1%, almost a record low. AAA bonds are yielding 2.0%, and BBB bonds, 2.4%.
