U.S. Interest Rates Chartbook March 2017
Takeaways The FOMC has raised the Fed funds rate for the third time since the start of the policy rate normalization cycle in 2015. The Committee has also reinforced its commitment to the gradual Fed funds rate increase in line with their projections of an additional two rate increases planned for 2017 Today s decision also reflects our view that waiting too long to scale back some accommodation could potentially require us to raise rates rapidly sometime down the road, which, in turn, could risk disrupting financial markets and pushing the economy into recession. March 15, 2017, Chair Yellen s March FOMC meeting Press Conference A couple more hikes this year seem reasonable. If the economy is a little bit stronger than we expect, we can do a little bit more. If it is a little bit weaker than we expect, we can do a little bit less. March 31, 2017, Bloomberg Interview with FRBNY President Dudley The Fed funds futures market is aligned with the Fed pricing in two more rate hikes in 2017 with an implied probability of 66% for the next rate increase in June, followed by a rate increase in 4Q17 The volatility in long-term yields has remained contained, coupled with an edged down term premium and lack of further upward pressure on inflation expectations Long-term treasury fluctuations have been holding steady against the backdrop of elevated policy uncertainties domestically and abroad We continue to expect a moderate increase in long-term yields, supported by higher expectations for growth and inflation
Unconventional Monetary Policy FEDERAL FUNDS RATE AND 10-YEAR TREASUREY NOTE (%) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0.5 First MBS Purchase QE2 08 09 10 11 12 13 14 15 16 17 10-Year Treasury Yield "Operation Twist" QE3 Taper Tantrum End of QE3 Federal Funds Rate 1st Rate Hike 3rd Rate Hike 2nd Rate Hike Source: BBVA Research, Federal Reserve Board and Haver Analytics 3
June Rate Hike Probability is at 66% FED FUNDS FUTURES IMPLIED PROBABILITIES, FOURTH 25BP HIKE (%) 100 90 80 70 60 50 40 30 20 10-12/27/2016 3/3/2017 3/24/2017 3/31/2017 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Source: BBVA Research and Bloomberg 4
Fifth Rate Hike is Priced in for 4Q17 FED FUNDS FUTURES IMPLIED PROBABILITIES, FIFTH 25BP HIKE (%) 100 90 80 70 60 50 40 30 20 10-03/03/17 03/24/17 03/31/17 Sep-17 Oct-17 Nov-17 Dec-17 Source: BBVA Research and Bloomberg 5
Fed Funds Futures Curve FED FUNDS FUTURES MOST RECENT, 1 WEEK PRIOR, 1 MONTH PRIOR, 3 MONTHS PRIOR (%) 2.25 2.00 1.75 1.50 1.25 0 0.75 0.50 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 12/27/2016 3/3/2017 3/24/2017 3/31/2017 Source: BBVA Research and Bloomberg 6
FOMC 2017 and 2018 Policy Firming Trajectory Medians Remain Unchanged PROJECTED PACE OF POLICY FIRMING (%) 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 0 2017 2018 2019 Long-Run FOMC Mean, Dec. 14, 2016 (±) 2 Standard Deviation Band, Dec. 14, 2016 FOMC Mean, Mar. 15, 2017 (±) 2 Standard Deviation Band, Mar. 15, 2017 Source: BBVA Research and Federal Reserve Board 7
BBVA Fed Funds Firming Pace Forecast FEDERAL FUNDS RATE (Upper Bound, %, End of Period) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0.5 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20 Actual Baseline Upside Downside Source: BBVA Research, Federal Reserve Board and Haver Analytics 8
BBVA Baseline Forecasts of Treasury Bill Yield 3-MONTH TO 12-MONTH RATES (%) 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0.5 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 3M 6M 12M Source: BBVA Research, Federal Reserve Board and Haver Analytics 9
Long-Term Yield Volatility Has Normalized Below Historic Mean 10-YEAR U.S. TREASURY NOTE VOLATILITY (Daily index) 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Index Mean since 2003 Index measures a constant 30-day expected volatility of 10-Year Treasury Note futures prices, and is calculated based on transparent pricing from Chicago Board of Trade's actively traded options on the Treasury Note futures Source: BBVA Research, Chicago Board Options Exchange and Bloomberg 10
Downward Pressure on Term Premium Resumed 10-YEAR U.S. TREASURY TERM PREMIUM & MARKET INFLATION EXPECTATIONS (Weekly, %) 3.5 3.0 2.5 2.0 1.5 0.5-0.5 - Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 10-Year U.S. Treasury Yield Implied 10-Year Spot Inflation Rate Average Expected Future Short Rates Ex-Ante Term Premium Source: BBVA Research and Federal Reserve Board 11
Mid-Term Duration-Risk Compression Has Normalized in the Vicinity of 15 Basis Points DURATION-RISK COMPRESSION (Daily, %) 0.6 0.5 0.4 0.3 0.2 0.1-0.1 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 5-Year to 3-Year Term Premium Spread Historic Mean since 1971 Calculated as the difference between 5-Year and 3-Year term premium reported by the New York Fed ACM (Adrian, Crump, and Moench) five-factor, no-arbitrage term structure model incorporating pricing factors. Source: BBVA Research, Federal Reserve Bank of New York and Haver Analytics 12
Long-Term Duration-Risk Compression Has Edged Down DURATION-RISK COMPRESSION (Daily, %) 0.8 0.6 0.4 0.2-0.2 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 10-Year to 5-Year Term Premium Spread Historic Mean since 1971 Calculated as the difference between 10-Year and 5-Year term premium reported by the New York Fed ACM (Adrian, Crump, and Moench) five-factor, no-arbitrage term structure model incorporating pricing factors. Source: BBVA Research, Federal Reserve Bank of New York and Haver Analytics 13
10-Year Treasury Yield Forecasts 10-YEAR U.S. TREASURY YIELD (%) 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Historic Baseline Downside Risk Upside Risk NABE* (EOP, Mar 26) SPF** (EOP, Feb 10) CBO*** (Yr. Avg, Jan 24) * National Association for Business Economics (NABE) Outlook median forecast compiled from a panel of NABE members. Last release date March 26, 2017 ** Survey of Professional Forecasters (SPF) conducted by Federal Reserve Bank of Philadelphia. Last release date February 10, 2017 *** Congressional Budget Office (CBO). Last release date January 24, 2017 Source: BBVA Research, NABE, FRB Philadelphia, CBO and Haver Analytics 14
Yield Curve Slope Forecasts TREASURY YIELD CURVE SLOPE (%, 10Y-2Y) 3.0 2.5 2.0 1.5 0.5-0.5 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Historic Baseline Downside Risk Upside Risk Source: BBVA Research, Federal Reserve Board and Haver Analytics 15
Yield Curve Forecasts TREASURY YIELD CURVE BASELINE FORECAST (%, End of Period) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0.5 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y 10-Year Average 2016 2017 2018 2019 Source: BBVA Research, Federal Reserve Board and Haver Analytics 16
Treasury Yield Curve Baseline Forecasts U.S. TREASURY YIELD CURVE (%) 6.0 5.0 4.0 3.0 2.0 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 2Y 3Y 5Y 10Y 30Y Treasury yield curve is estimated with a three-factor no-arbitrage model linked to macroeconomic factors measuring growth, inflation and monetary policy. Estimates are based on BBVA Research baseline forecast for GDP growth, inflation and Fed funds rate. Source: BBVA Research, Federal Reserve Board and Haver Analytics 17
Swap Curve Baseline Forecasts U.S. SWAP RATES (%) 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0.5 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 2Y 3Y 5Y 10Y 30Y. Source: BBVA Research and Bloomberg 18
LIBOR Curve Baseline Forecasts U.S. DOLLAR LIBOR RATES (%) 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0.5 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 1M 3M 6M 12M. Source: BBVA Research, Federal Reserve Board and Haver Analytics 19
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