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Falling Interest Rates

The Federal Reserve announced its expectation not to raise short-term interest rates any more in 2019, reflecting a more subdued forecast for economic growth in the remainder of the year.  Previously, the Fed had indicated that it expected to hike short term rates by a quarter percentage point twice more in 2019.  The current Fed Funds target rate will remain at 2.25-2.5%.  [1]

The announcement has several important implications for the financial markets and for U.S. consumers, most of which are generally positive.  At least initially, the response to the rate hike pause was well-received.  Following the announcement, the U.S. stock market rallied, along with other risk assets like commodities and credit.  A pause in rate hikes is accommodative and signals that the Fed does not want to accelerate a recession through overly tight monetary conditions.

Interest rates across the maturity curve fell as a result of the Fed announcement.  This was a positive development for those holding existing bonds, as the value of bonds rises when interest rates fall.  The 10 Year US Treasury Bond ended the day with a yield of 2.52%, its lowest level since January of 2018.

In addition, consumers now face potentially lower debt costs.  US Mortgage rates are tied to the 10 Year US Treasury Bond rate.  As the 10 Year falls, so do the rates of 30-year fixed rate mortgages in the US.  Variable loans will now be more manageable for US consumers.  Variable rate loans for mortgages, credit cards and other assets are typically tied to LIBOR, the London Interbank Offer Rate.  LIBOR goes up and down based up on the Fed’s short-term target rate.  In short, variable rate loan costs will likely stay flat this year with the Fed expected not to hike rates any further.

One negative is that savers will not receive any more bumps in interest to their cash accounts.  In what has become a very welcome outcome in the past year, the yield on savings accounts at banks has risen to above 2% in many places.  This has been a change from several years ago, when bank accounts yielded virtually zero.  While the rates on savings accounts are not likely to rise in the coming months, they should stay flat, given the Fed’s outlook.  At 2% or 2.25% on cash, at least savers are receiving some compensation without having to take market risk.

Looking ahead, we expect interest rates to be relatively range bound.  The Fed has indicated a pause for the rest of the year in short-term rates.  On the longer end of the yield curve, competing forces are likely to keep interest rates from moving much higher or lower.  Low inflation expectations and modestly positive economic growth will provide a counter-balance to one another, most likely leaving the 10 Year US Treasury yielding between 2.5%-3.5%.  In this environment of still-low interest rates and relative stability, we view conditions as favorable for financial markets.

[1] “Fed Leaves Rates Unchanged.” CNBC.com 3/20/2019. https://www.cnbc.com/2019/03/20/fed-leaves-rates-unchanged.html