Today we are going to talk once again about what’s happening with interest rates.
The 10yr Treasury is floating right around 2.90%, up 50bps on the year. With Jerome Powell now at the helm of the Federal Reserve it’s important to look at what are his thoughts on the economy and interest rates. This week he appeared very optimistic about the economy and the possibility that the FOMC raises rates 3 and possibly 4 times this year.
His reasoning is 1) continued strength in the labor market, 2) some evidence of rising inflation, 3) continued strength in the global economy and 4) recent stimulative fiscal policy such as tax reform.
Getting back on the inflation front, take a look at the following graph. This shows the Fed’s preferred inflation measurement, PCE, on an annualized basis. As you can see inflation is starting to move higher but whether or not it reaches the Fed’s target of 2% is still unknown.
Speaking of unknowns, the impact of the Republican tax bill will be difficult to measure for a few months at least. There is a presumption that it will raise the economy and inflation with it. The Fed’s expectation is rising inflation will continue and that will lead to more interest rates increases. It’s safe to say that 3 interest rate increases are fairly certain and if inflation continues to climb then 4 increases is a good probability.
In terms of Treasury rates, the 10yr is still holding below 3% but the more interesting move is on the 2yr Treasury which continues to rise. The graph on your screen shows both the 2yr and 10yr Treasury rising, but the 2yr Treasury is rising faster and closing the gap. Even though mortgage rates are more closely tied to the 10yr, the rapidly rising 2yr does put upward pressure on mortgage rates.
The reason the 2yr continues to rise faster is the expectation that the Fed will continue to increase short term rates. In fact the market prices in a 100% chance the Fed raises rates on March 21st versus 68% at year end. The probably of 3 rate increases in 2018 is 72% and 4 increases is 34%.
In the coming weeks you should keep an eye on the following items:
- Will the prospects of 4 interest rate increases push the 10yr over 3%?
- Inflation data and specifically Core PCE, will it continue to move higher?
- Any further comments from Jerome Powell as the market becomes more familiar with the new Fed Chair