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A New World for Interest Rates

twald_fall16

Since the surprise election of Donald Trump two weeks ago, interest rates have taken a sharp upward turn. Perhaps best exemplifying this is the yield on the 10-year Treasury, which has now exceeded 2.30%, rising more than .50% since Election Day and .95% from last July when it fell to an all-time low of 1.37% in the immediate aftermath of Brexit. The move in rates since the polls closed on November 8 has been fast and dramatic and for the most part has shattered the previous notion that we had re-entered a “lower for longer” rate environment based on global uncertainties and a tentative Federal Reserve (Fed). In many ways it’s now a new world for interest rates, and while global uncertainties and the Fed still exist, we no longer believe they will be suppressing rates as they had before.

In assessing precisely what has happened to market interest rates over these past weeks we would summarize the following:

  • Interest rates began rising the morning of November 9 as the market quickly judged the future Trump economic agenda to be significantly more inflationary than any the U.S. has seen in more than a decade.
  • Reasons for this market reaction were likely based on the expectations that a Trump administration would put forth legislation and policy based on lower corporate and personal taxes, overseas tax repatriation, higher levels of infrastructure spending and less financial regulation.
  • In order to initially finance such policy, it is also widely believed that U.S. debt and federal deficits could increase, at least until higher levels of growth in the economy are achieved.

So in summary, the move in rates reflect expectations of higher inflation and higher federal deficits both of which equate to higher interest rates and that is certainly what we have seen in the days since the election. With this in mind, here are some of our thoughts looking forward:

  • We believe the Fed will raise the Fed Funds rate at its December meeting by a quarter point. More rate hikes are likely to follow throughout 2017.
  • We also believe the Fed now essentially has “cover” it did not have before the election regarding the market effects of increasing rates. It has been our feeling that ever since its lone rate hike of last December, and the stock market correction that immediately ensued during January and February, the Fed has been reluctant to hike rates for fear of negatively impacting the equity markets. Now they no longer have to worry about that.
  • Since the stock market has rallied over these past few weeks, and the Dow Jones and S&P 500 have reached record levels, the Fed will likely downplay its “data dependent” persona and use the next several months as an opportunity to catch up on the lost time that was the year of 2016. In some ways it’s almost as if we are right back where were a year ago – a December rate hike with expectations of perhaps three or four to follow in the year ahead. (The only difference of course being that a full year has passed, the Cubs have won their first World Series in 108 years and Donald Trump is now president).
  • Fiscal policy, the means by which government adjusts its spending levels and tax rates to monitor and influence the nation’s economy, will now play a much larger role in the expectation of interest rates than it has since the early days of 2009. For more than seven years the U.S. economy has been highly dependent on monetary policy only, and this change we believe will help to push rates higher in the year ahead.
  • We also believe there could be a case of pent up demand in the economy during the year ahead stemming from increasing wage growth, higher personal savings, and stronger consumer spending. Should these trends result in higher levels of GDP growth, perhaps close to 3% as appears may have been the case in 3Q based on its initial estimate, then further rationale will fall into place for higher rates.

Finally, we would caution that all of this having been said, rates have moved very far and very fast, reflecting that much of this has been taken into account. For this reason, we likely see rates as range bound within about .25% of current levels (about 2.30% on the  10-year Treasury) between now and the New Year. However the playing field has clearly changed as all eyes are now fixating higher than they were just a few weeks ago.

 

Tom Wald is responsible for overseeing the investment and mutual fund product development functions and sub-adviser selection process. He also actively publicizes Transamerica’s investment thought leadership and products to advisors, clients, and the media. Tom has more than 25 years of investment experience and has managed large mutual funds and sub-advised separate account portfolios. Tom holds a bachelor’s degree in political science from Tulane University and an MBA in finance from the Wharton School at the University of Pennsylvania. He has earned the right to use the Chartered Financial Analyst (CFA) designation. 

Investments are subject to market risk, including the loss of principal. Asset classes or investment strategies described may not be suitable for all investors.

The information included in this article should not be construed as investment advice or a recommendation for the purchase or sale of any security. This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information does not take into account any investor’s investment objectives, particular needs or financial situation. The value of any investment may fluctuate. This is a general perspective about market volatility and our market outlook and is not intended to predict future events. 

Transamerica Funds are advised by Transamerica Asset Management, Inc. and distributed by Transamerica Capital, Inc.

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