Interest Rates – Where to From Here? 2019 Update

by and | Dec 4, 2019 | Industry Updates, Investment

In May of this year, we released our view on the current state of interest rates including the specific drivers that could affect rates through the end of 2019. Over the past seven months, a lot has happened with the various forces that have influenced interest rates globally. This quick update summarizes those forces and provides our thoughts on what might happen based on where we are today.

 

 

The Fed:

Back in May, we were skeptical of any additional rate hikes from the Fed without significant pickup in inflation and/or real GDP.  Since that time, global economic activity took a turn for the worse, with softening economic indicators due to trade and other geopolitical events.  As a result, the market began pricing in several Fed rate cuts, causing the 2-Year and 10-Year Treasury rates to temporarily invert.  In light of the global slowdown, the Fed has taken out some economic insurance by cutting interest rates three times over the last six months (0.25% in July, September and October).

Commentary from the Fed suggests that the level of the Fed Funds Rate is appropriate and that increases or decreases are unlikely barring any significant changes in the economy.

 

Long-Term Interest Rates:

Long-term rates also moved dramatically over the last six months. The 10-Year Treasury moved substantially lower – bottoming out around 1.45% in late August. This represented a decline of roughly 100 basis points over the last six months. Similar declines were evident with long corporate yields over the same time horizon.

This drop in rates was largely due to the slowdown in the global economy. Incited by trade tension, Brexit uncertainty, and other geopolitical events, this slowdown triggered a flight to safety and drove interest rates lower.  Negative interest rates (particularly in Germany and Japan) spurred demand for US fixed income, pulling rates in the US even lower.

 

Where To From Here – Update

Without a substantial pick-up in global economic growth, especially in places like Germany and/or easing trade tensions between the US and China, it is difficult to see how rates could move substantially higher.  While the 10-Year Treasury rate has bounced up from the lows of August due to softening trade tensions and modestly improved economic activity, it is still a long way away from the 3.25% high from October 2018.

Markets have reacted quickly to any news (good or bad) which has resulted in large swings in interest rates. Borrowing costs, the outlook for improving economic indicators, and fair equity valuations (globally) should provide a supportive environment for interest rates to grind a bit higher over the coming months.  The big question will be whether these conditions are more than offset by any resurgence in geopolitical events (old or new) that drive investors back into the safety of bonds, which would keep rates low (or push them lower). Currently our view is that we are more likely to see positives from improving fundamentals to outweigh any known negatives, helping interest rates to grind modestly higher in the coming year.

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