Flattening Yield Curve Signals Single Remaining Rate Hike in 2018
ATLANTA–Expect the Federal Reserve to raise interest rates in September, then hold firm until long-term interest rates inch up, Rajeev Dhawan of the Economic Forecasting Center at Georgia State University’s J. Mack Robinson College of Business says.
“In his July testimony, Fed Chairman Jay Powell pretty much sealed September’s rate hike,” Dhawan wrote in his ‘Forecast of the Nation,’ released Wednesday, Aug. 29,. “The only justification for delay would be a calamitous drop in financial markets in the next 30 days.”
Foreign currency crises in Argentina and Turkey, as well as the weakening yuan (China), real (Brazil) and ruble (Russia), could raise caution at the Fed. Another cause for concern among economists and the financial press is the tightening U.S. yield curve, which shows interest rates for Treasurys with maturities from one to 30 years.
“Some flatness is to be expected as the Fed raises the short end of the yield curve,” Dhawan wrote. “The problem is the long end o has barely budged, even as the short end has risen by 100 basis points.”
Dhawan pointed to the 20-odd basis point spread between two-year and 10-year Treasurys as the reason for only one more rate hike in 2018. If the ongoing emerging market currency crisis intensifies further and affects U.S. financial markets, especially investors flocking to Treasurys for safety, it could wipe out the remaining spread and jeopardize the September rate hike.
“For future rate hikes, the Fed will wait for long bond yields to inch up,” Dhawan said. “When the Treasury Department goes to market to finance more debt, I anticipate the long bond yield will rise.”
Look for the Federal Reserve to take a pause from raising rates in December and restart in 2019, resuming their watchful course of raising rates, he said.
“The Fed always watches inflation, which measures the heat of the economy. But inflation is well within the target range of two percent and current economic growth is running at just about 3.0 percent,” Dhawan said. “To sustain this growth we will need to see the currently good investment numbers get even stronger, and investment will need to grow at a high double-digit clip, as it did in the late ’90s, for the U.S. economic supertanker to speed ahead at more than four percent growth.”
Intensifying trade spats with the nation’s major trading partners are creating uncertainty for future growth, he said.
“The first round effect of trade spats is postponement of domestic investment expenditures,” Dhawan said. “But the real damage occurs when retaliation by allies results in upheaval in the Treasury bond market. This does not appear likely yet, but the game is still young.”
Highlights from the Economic Forecasting Center’s National Report
- Following robust GDP growth of 4.1 percent in the second quarter of 2018, the economy will expand at 2.8 percent in 2018, 2.4 percent in 2019 and 2 percent in 2020.
- Business investment grew 7.3 percent in 2018’s second quarter. Expect growth to finish at 7.4 percent in 2018, 5.8 percent in 2019 and 4.9 percent in 2020. Jobs will grow by a monthly rate of 205,000 in 2018, 142,600 in 2019 and 125,700 in 2020.
- Housing starts will average 1.283 million units in 2018, fall slightly to 1.258 in 2019 and rise to 1.300 in 2020. Expect auto sales of 16.8 million units in 2018, 16 million in 2019 and 15.8 in 2020.
- The 10-year bond rate will average 3.1 percent in 2018, 3.9 percent in 2019 and 4 percent in 2020.