Mason Investment Group, LLC

Bigger Deficits Yield Higher Interest Rates

Long-term interest rates’ climb since December is largely because of the unexpectedly bigger government deficits associated with Republicans’ tax cuts. The pending two-year budget agreement on Capitol Hill will spend even more, piling onto the deficit, thus boosting interest rates. Lawmakers are set to prove that about the only things they can agree on are slashing revenue to the treasury and leaving it full of IOUs. Hence, most of the legislation in the works with a chance of passing (infrastructure or border security, for example) will add to the deficit. And that means more government borrowing.

An inflation scare added to the upswing in interest rates but should abate. A bump up in reported wage growth caused rates to rise on an inflation scare at the beginning of February. But, for technical reasons, next month’s wage growth is likely to come back down when the new employment report is issued March 9. However, although inflation will rise a tad this year as the economy picks up, it will not start a new upward trend. But deficit concerns will remain.

The Federal Reserve will keep raising short-term interest rates because the central bank is focused on the falling unemployment rate and other indicators that show a tightening labor market. The Fed very much wants to stay ahead of any inflation that rising wages may generate and will lift short-term rates by a quarter of a percentage point three times in 2018 (in March, June and December). That will put the federal funds rate at 2.25% heading into 2019.

We think today’s 2.8% yield on the 10-year Treasury note will hit 3.3% by the end of 2018. The bank prime rate that auto loans and home equity loans are based on will bump up from 4.25% to 5.25% by year’s end. The 30-year fixed mortgage rate is likely to go up to 4.6% from today’s 4.2%. The 15-year fixed mortgage rate should rise to 4.2% from today’s 3.7%.

Source: Bigger Deficits Yield Higher Interest Rates (David Payne, 2/28/2018)  –