Are Interest Rates Too Optimistic?

Written by: Global Thought Leadership | November 15, 2018

Source: Bloomberg, as of November 12, 2018. *5-Year, 5-Year Forward Rate. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • The pace of economic growth is likely to have significant bearing on interest rates in 2019.
  • The Federal Reserve’s assessment about growth has been generally upbeat, and that optimism seems to be shared by the bond market.
  • That’s evident in part from U.S. Treasury futures – which suggest a rate scenario notably higher than the Fed’s current estimate of the rate consistent with full employment and capacity utilization, and stable prices – known as the “neutral” or “terminal” rate.
  • Certainly U.S. growth has been strong this year, perhaps creating an optimistic bias in the market for strong growth to continue.
  • But there are reasons to believe that growth could moderate as the fiscal stimulus fades and rate increases begin to bite.

What our managers are saying:

 

 


All data Source: Bloomberg as of November 15, 2018, unless otherwise noted.

Definitions:

The 5-year, 5-year Forward Rate is a measure of expected inflation derived from "nominal" Treasury securities and their "real" counterparts—inflation-protected TIPS securities.

The Federal Funds Rate (Fed Funds Rate, Fed Funds Target Rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The terminal rate is what economists call the natural or neutral interest rate. It is the rate that is consistent full employment and capacity utilization and stable prices.

 

Top

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.