Rates Headed Up As Investors Look To 2017 Kiplingers Latest Forecast On Interest Rates IStockphoto

Rates Headed Up As Investors Look To 2017 Kiplingers Latest Forecast On Interest Rates IStockphoto

Bond investors likely overreacted to Fed Chair Yellen’s announcement that the Fed now expects three quarter-point rate hikes in 2017 instead of two. Fed Board members have predicted rate hikes in the past that never materialized, and bond market investors prudently discounted them. But sentiment has shifted, and rates are headed up now. The only question is whether nervous bond investors will continue to push up yields by dumping bonds.

Despite the Fed’s expectation of three rate hikes, figure on just two in 2017, because economic growth won’t be strong enough to warrant a faster rise in interest rates. The fiscal stimulus effects of President-elect Donald Trump’s proposed tax cuts will be mostly pushed into 2018, while the high value of the U.S. dollar and rising long-term interest rates will weigh on the economy in 2017.

But there are legitimate reasons to expect higher long-term interest rates. Inflation is likely to pick up a bit as energy prices firm. And the tax cuts that Trump and the Republican-controlled Congress are likely to enact next year will gradually start to boost the economy. In addition, it is widely expected that Trump’s policy proposals will cause significantly higher government budget deficits, which may boost the supply of Treasuries and thus push yields higher. Finally, a tighter labor market is likely to push up wage growth a bit next year. That may stoke inflation and force interest rates higher, though inflation tends to lag wage growth by a year or more.

SEE ALSO:All Our Economic Outlooks

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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 2.6% currently. While there is considerable uncertainty about how much energy prices will rise, and about the ultimate economic impact of Trump’s tax cuts and other policies, the trend in rates will be upward in the near term.

The Federal Reserve raised short-term rates by a quarter-point on December 14. Decent employment reports for the past four months and a fall in the unemployment rate indicate that the labor market is tightening, giving the Fed a solid case for hiking. The central bank has previously cited concerns about labor market slack as the main reason not to raise rates earlier.

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

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

Source: Federal Reserve, Open Market Committee


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Dated: January 3rd 2017
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