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:
- “We view optimism about U.S. growth as a bit overdone… we expect [it] to slow slightly next year with inflation remaining moderate… global monetary policy will continue to play a major role in the recovery…we expect more volatility such as that we saw this year should central banks misjudge the market or mishandle communication regarding policy moves.” – Western Asset Chief Investment Officer Ken Leech
- “…the Trump tax cutting agenda has complicated the issue [of rate normalization] by rocketing American GDP growth higher, which could easily bias/pressure the Fed into thinking a rapid normalization is appropriate. But there are a host of reasons for believing that normalization will play out over a very long time frame.” - Francis Scotland, Director of Global Macro Research, Brandywine Global
All data Source: Bloomberg as of November 15, 2018, unless otherwise noted.
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.