Where Are Interest Rates Going?

*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in the article may not develop as predicted and there can be no guarantee the strategies promoted will be successful.   All charts can be obtained from www.federalreserve.gov

The dots in the charts represent the estimations of future interest rates by Federal Reserve Open Market Operations Committee members referred to as the FOMC

Where are interest rates going?

m

Click for Video

When people talk about interest rates rising what they are generally referring to is the Fed Funds rate. This is the amount banks charge each other to lend money overnight to each other.

However this rate effects all the other rates if for no other reason than perception and investor psychology. The 10 yr us treasury bond rate which hit 1.6% earlier this week is determined by supply and demand. There was record foreign demand due to the fact many central banks around the world are actually imposing negative rates. That’s a whole other can of worms that I will discuss in a later post.

Technically you could have a large scale rise in the US treasury rates that didn’t come from a change in FED Funds rates but for the most part the FED Funds rate is the rate everyone talks about.

So where are rates going?   The best place to find this information is from the Federalreserve.gov website.   Today (6/15/16) was the start of a two day meeting where the FED released what they call their Dot Plots.   See below for today’s release on the FED’s website.

 

The FED dot plots consist of both voting and non-voting members of the FOMC or Federal Open Market Committee.

 

What’s interesting to note is that all of the FOMC members expect the Fed Funds rate to be at least .5% by January of 2017.   The other two interesting points is that 1 voting member expects this to persist for at least 2 more years and that the longer run consensus is around 3%.

 

For some context here are previously released dot plots starting with June 2012

       June 2014 Dot Plot

m4

My interesting take away is that as long as the pain isn’t being felt today, it’s easy to say longer term rates will be 3% but what it’s too easy and tempting to kick that can down the road.

The other factor in all of this is the FED Funds rate isn’t the rate the Gov’t borrows money at. That could be an entirely different video breaking down how that works but I digress. Today with the rate being near all-time lows it’s still 1.6% when the FED Funds rate is .25%.   Now anyone with a calculator can see what could happen if FED Fund rates were hypothetically 3% and assuming the government could borrow at let’s say 5%.   Presumably the debt by then could easily be above 20Trillion which means a nice hefty interest payment of $1 trillion per year.

Now can you see why it’s better to kick the can down the road?   The FED, in my opinion is using Open mouth operations instead of open market operations and they are trying to bolster the market using their perceived economic confidence in the hopes they can create a self-fulfilling prophecy. It has worked for the past 1.5 years since they became serious about raising rates, but at some point the market will call their bluff.

The last thing to keep in mind is Donald Trump has openly said he would replace Janet Yellen.  If you knew your job was on the line and rising rates might upset the current apple cart, would you be inclined to not raise rates?

And there is your answer. The Fed will more than likely raise rates once to maintain some semblance of credibility but after the election the FED might be able to give a more honest assessment of the economic conditions. The one saving grace the FED has is other central banks are negative which helps drive demand in our bond market. Absent foreign demand we might have seen the market raise rates and eventually the market and not the FED will determine when rates will rise.

From today’s dot plots I tend to agree with the one member who came in way below consensus. As for the other members I hope their budget allows for a calculator.

m5

 

Cheers,

Tim Picciott