U.S. Interest Rates Chartbook September 2017
Takeaways The FOMC announced the start of the balance sheet normalization process to begin in October while maintained the Fed funds rate target range at 1%-1.25% The FOMC participants trajectory for the Fed funds rate has maintained an additional rate hike by the end of 2017, revealed elevated uncertainty around the 2018-2020 path, while the longer-run median declined by 25 basis points The Fed funds futures market has aligned with the FOMC, pricing in a December 2017 rate hike with a 78% implied probability As geopolitical risks take backstage, the 10-Year Treasury yield has normalized to the higher rates seen in July, in line with attrition of the Fed s reinvestment policy already priced in The yield curve is expected to flatten due to upward pressure on short-term rates from the Fed funds rate hikes while long-term yields will remain under downward pressure from safe-haven flows and low term-premium
Unconventional Monetary Policy FEDERAL FUNDS RATE AND 10-YEAR TREASURY NOTE (%) 5.0 4.5 4.0 3.5 3.0 2.5 First MBS Purchase QE2 "Operation Twist" QE3 Start QE3 Taper Taper Tantrum 1st Rate Hike 2nd Rate Hike 4th Rate Hike 3rd Rate Hike 2.0 1.5 1.0 0.5 0.0 08 09 10 11 12 13 14 15 16 17 10-Year Treasury Yield Federal Funds Rate Source: BBVA Research, Federal Reserve Board and Haver Analytics 3
FOMC 2017 and 2018 Policy Firming Trajectory Medians Remain Unchanged with a 25 Basis Points Decline in the Longer-Run PROJECTED PACE OF POLICY FIRMING (%) 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 2017 2018 2019 2020 Long-Run FOMC Mean, June 14, 2017 (±) 2 Standard Deviation Band, June 14, 2017 FOMC Mean, Sep. 20, 2017 (±) 2 Standard Deviation Band, Sep. 20, 2017 FOMC Median, June 14, 2017 FOMC Median, Sep. 20, 2017 Source: BBVA Research, Federal Reserve Bank of New York and Federal Reserve Board 4
A Fifth Rate Hike is Priced in for December 2017 FED FUNDS FUTURES IMPLIED PROBABILITIES, FIFTH 25BP HIKE (%) 100 90 80 70 60 50 40 30 20 10-08/31/17 09/21/17 09/28/17 Nov-17 Dec-17 Jan-18 Mar-18 Source: BBVA Research and Bloomberg 5
Fed Funds Futures Rise as the FOMC Near-Term Policy Outlook Firms FED FUNDS FUTURES MOST RECENT, 1 WEEK PRIOR, 1 MONTH PRIOR, 3 MONTHS PRIOR (%) 1.875 1.750 1.625 1.500 1.375 1.250 1.125 1.000 0.875 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 6/22/2017 8/31/2017 9/21/2017 9/28/2017 Source: BBVA Research and Bloomberg 6
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 1.0 0.5 0.0 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 FOMC Median, Sep. 20, 2017 Source: BBVA Research, Federal Reserve Board and Haver Analytics 7
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 1.0 0.5 0.0 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 3M 6M 12M Source: BBVA Research, Federal Reserve Board and Haver Analytics 8
Baseline Forecast of Federal Reserve s Balance Sheet FEDERAL RESERVE TOTAL FACTORS SUPPLYING RESERVE FUNDS (Monthly, Trillions $) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Treasuries MBS Total Holdings Source: BBVA Research and Federal Reserve Board 9
Treasuries Monthly Attrition Will Start with $6 Billion Cap in October and Increase to Reach $30 Billion per Month SOMA* TREASURY SECURITIES MATURITY PROFILE (Monthly, Billions $) 80 70 60 50 40 30 20 10 0 2017 2018 2019 Treasuries Redemptions Treasuries Reinvestments Treasuries Cap * The Federal Reserve System Open Market Account (SOMA) is a portfolio of U.S. Treasury and Federal Agency securities, foreign currency investments and reciprocal currency arrangements. Source: BBVA Research and Federal Reserve Board 10
Agency Securities Monthly Attrition Will Start with $4 Billion Cap in October and Increase to Reach $20 Billion per Month SOMA* AGENCY DEBT AND MBS** PAY-DOWN PROFILE (Monthly, Billions $) 45 40 35 30 25 20 15 10 5 0 2017 2018 2019 MBS and Agency Redemptions MBS and Agency Reinvestments MBS Cap The Federal Reserve System Open Market Account (SOMA) is a portfolio of U.S. Treasury and Federal Agency securities, foreign currency investments and reciprocal currency arrangements. ** Mortgage-backed security Source: BBVA Research and Federal Reserve Board 11
Slow Adjustment of Term Premium to Balance Sheet Normalization 10-YEAR U.S. TREASURY TERM PREMIUM IMPACT (Basis Points, Term Premium Effect = -100) 0-20 -40-60 -80-100 -120-140 FRB Calculated* Effect FRB 90% Confidence Interval BBVA Baseline Effect BBVA 90% Confidence Interval Bonis, Brian, Jane Ihrig, and Min Wei (2017). "Projected Evolution of the SOMA Portfolio and the 10-year Treasury Term Premium Effect," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, September 22, 2017, https://doi.org/10.17016/2380-7172.2081. $613 billion longer-run reserve balance scenario. Source: BBVA Research and Federal Reserve Board 12
Long-Term Yield Volatility Has Normalized Substantially Below Its 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 Jul-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 the Chicago Board of Trade's actively traded options on the Treasury Note futures Source: BBVA Research, Chicago Board Options Exchange and Bloomberg 13
Downward Pressure on Term Premium Softens 10-YEAR U.S. TREASURY TERM PREMIUM & MARKET INFLATION EXPECTATIONS (Weekly, %) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 10-Year U.S. Treasury Yield Average Expected Future Short Rates Implied 10-Year Spot Inflation Rate Ex-Ante Term Premium Source: BBVA Research, Federal Reserve Board and Federal Reserve Bank of New York 14
Mid-Term Duration-Risk Compression Has Declined to 5 Basis Points DURATION-RISK COMPRESSION (Daily, %) 0.6 0.5 0.4 0.3 0.2 0.1 0.0-0.1 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-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 15
Long-Term Duration-Risk Compression Has Declined to Lows of 2 Basis Points DURATION-RISK COMPRESSION (Daily, %) 1.0 0.8 0.6 0.4 0.2 0.0-0.2 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-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 16
Futures Discount an 3.5 Basis Points Raise in 10-Year Treasury Yield Over the Next 3 Quarters 10-YEAR U.S. TREASURY YIELD FUTURES MOST RECENT, 1 WEEK PRIOR, 4 WEEKS PRIOR, 8 WEEKS PRIOR (%) 3.138 3.075 3.013 2.950 2.888 2.825 Dec-17 Mar-18 Jun-18 8/31/17 9/21/17 9/28/17 Source: BBVA Research and Bloomberg 17
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 1.0 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Historic Baseline Downside Risk Upside Risk NABE* (EOP, Sep 24) SPF** (EOP, Aug. 11) CBO*** (Yr. Avg, Jun 29) Administration**** (Yr.Avg, May 23) * National Association for Business Economics (NABE) Outlook median forecast compiled from a panel of NABE members. Last release date September 24, 2017 ** Survey of Professional Forecasters (SPF) conducted by Federal Reserve Bank of Philadelphia. Last release date August11, 2017 *** Congressional Budget Office (CBO). Last release date June 29, 2017 **** Administration: 2018 Budget. Last release date May 23, 2017 Source: BBVA Research, NABE, FRB Philadelphia, FRB New York, CBO and Haver Analytics 18
Yield Curve Slope Forecasts TREASURY YIELD CURVE SLOPE (%, 10Y-2Y) 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5 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 19
Treasury Yield Curve Baseline Forecasts U.S. TREASURY YIELD CURVE (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 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 20
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 1.0 0.5 0.0 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y 10-Year Average 2016 2017* 2018* 2019* 2020* *BBVA Research baseline forecast. 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 21
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 1.0 0.5 0.0 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 2Y 3Y 5Y 10Y 30Y Source: BBVA Research, Federal Reserve Board and Haver Analytics 22
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 1.0 0.5 0.0 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 1M 3M 6M 12M Source: BBVA Research, Federal Reserve Board and Haver Analytics 23
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