U.S. Interest Rates Chartbook January 2018
Takeaways In line with expectations, the FOMC left Fed funds rate unchanged. The changes to the January statement highlighted stronger growth and confidence that inflation will stabilize at the target rate of 2% in 2018. The committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate Fed funds futures are pricing in three rate increases for 2018. A March rate increase is fully priced in and the implied probability for a subsequent hike in June is at 76%. The 2-year to 30-year Treasury yields have increased in monotone by 25-30 basis points since the end of December. Consumer rates followed suit. An increase in yields is supported by a soft but sustained increase in Inflation expectations. Term premium remains negative coupled with a low market volatility environment. The yield spread between the 2-year and 10-year Treasury notes remains at an average at 55 basis points, its lowest level since Fall 2007. The baseline remains for a gradual increase in long-term yields with an upward bias for 2018 year-end long-term rates. The economic environment over the medium-term implies that the yield curve will flatten further.
Unconventional monetary policy FEDERAL FUNDS RATE AND 10-YEAR TREASURY NOTE 5.0 4.5 4.0 3.5 3.0 First MBS Purchase QE2 "Operation Twist" QE3 Start QE3 Taper Taper Tantrum 1st Rate Hike 2nd Rate Hike 3rd Rate Hike 4th Rate Hike 5th Rate Hike 2.5 2.0 1.5 1.0 0.5 0.0 08 09 10 11 12 13 14 15 16 17 18 10-Year Treasury Yield Federal Funds Rate Source: BBVA Research, Federal Reserve Board and Haver Analytics 3
Dealers expectations for the long-run fed funds rate remain in line with the median FOMC projection of 2.75% 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 Dealers Survey Median, Ded 4, 2017 Dealers Expected Median of FOMC FFR SEP (EOP) (±) 25th Percentile FOMC Median, Dec. 13, 2017 (EOP) Survey of Primary Dealers is formulated by the Trading Desk at the Federal Reserve Bank of New York. Last received date December 4, 2017 Source: BBVA Research, Federal Reserve Bank of New York and Federal Reserve Board 4
Fed funds futures continue to align with FOMC 2018 trajectory FED FUNDS FUTURES MOST RECENT, 1 WEEK PRIOR, 1 MONTH PRIOR, 3 MONTHS PRIOR 2.625 2.500 2.375 2.250 2.125 2.000 1.875 1.750 1.625 1.500 1.375 1.250 1.125 1.000 Feb-18 May-18 Aug-18 Nov-18 Feb-19 May-19 Aug-19 Nov-19 Feb-20 May-20 Aug-20 Nov-20 10/24/2017 1/2/2018 1/23/2018 1/30/2018 Source: BBVA Research and Bloomberg 5
Fully priced in March rate hike and 76% probability of a seventh rate increase in June FED FUNDS FUTURES IMPLIED PROBABILITIES, SEVENTH 25BP HIKE 100 90 80 70 60 50 40 30 20 10-01/02/18 01/23/18 01/30/18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Source: BBVA Research and Bloomberg 6
Fed funds firming pace forecast FEDERAL FUNDS RATE (%, Upper Bound, End of Period) 6.0 5.0 4.0 3.0 2.0 1.0 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, Dec. 13, 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
Long-term yield volatility remains low relative to 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 3.0 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 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 9
Upward pressure on inflation expectations while term premium remains negative 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 10-Year U.S. Treasury Yield Implied 10-Year Spot Inflation Rate Average Expected Future Short Rates Ex-Ante Term Premium Source: BBVA Research, Federal Reserve Board and Federal Reserve Bank of New York 10
Mid-term duration-risk compression remains in near zero territory DURATION-RISK COMPRESSION (Daily, %) 0.6 0.5 0.4 0.3 0.2 0.1 0.0-0.1 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 11
Long-term duration-risk compression remains in negative territory DURATION-RISK COMPRESSION (Daily, %) 1.0 0.8 0.6 0.4 0.2 0.0-0.2 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 12
Dealers expectations are for gradual increase in the 10-year Treasury yield PROJECTED 10-YEAR TREASURY YIELD 3.70 3.60 3.50 3.40 3.30 3.20 3.10 3.00 2.90 2.80 2.70 2.60 2.50 2.40 2.30 Dealers Survey Median, Ded 4, 2017 (±) 25th Percentile BBVA Baseline Survey of Primary Dealers is formulated by the Trading Desk at the Federal Reserve Bank of New York. Last received date December 4, 2017 Source: BBVA Research, Federal Reserve Bank of New York and Federal Reserve Board 13
Dealers expectations are for gradual increase in the mortgage rate stabilizing at 4.8% PROJECTED 30-YEAR FIXED PRIMARY MORTGAGE RATE 5.40 5.30 5.20 5.10 5.00 4.90 4.80 4.70 4.60 4.50 4.40 4.30 4.20 4.10 4.00 3.90 3.80 Dealers Survey Median, Ded 4, 2017 (±) 25th Percentile BBVA Baseline Survey of Primary Dealers is formulated by the Trading Desk at the Federal Reserve Bank of New York. Last received date December 4, 2017 Source: BBVA Research, Federal Reserve Bank of New York and Federal Reserve Board 14
Futures discount a 10 basis point rise in 10-year Treasury yields over the next 3 quarters 10-YEAR U.S. TREASURY YIELD FUTURES MOST RECENT, 1 WEEK PRIOR, 4 WEEKS PRIOR 3.560 3.535 3.510 3.485 3.460 3.435 3.410 3.385 3.360 3.335 3.310 3.285 3.260 3.235 3.210 3.185 3.160 3.135 3.110 Mar-18 Jun-18 Sep-18 1/2/2018 1/23/2018 1/30/2018 Source: BBVA Research and Bloomberg 15
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, Dec. 3) SPF** (EOP, Nov. 13) CBO*** (Yr. Avg, Jun. 29) WSJ EFS^ (EOP, Jan. 1) * National Association for Business Economics (NABE) Outlook median forecast compiled from a panel of NABE members. Last release date December 3, 2017 ** Survey of Professional Forecasters (SPF) conducted by Federal Reserve Bank of Philadelphia. Last release date November 13, 2017 *** Congressional Budget Office (CBO). Last release date June 29, 2017 ^ Economic Forecasting Survey. The Wall Street Journal surveys a group of more than 60 economists on a monthly basis. Last release date January 1, 2018 Source: BBVA Research, NABE, FRB Philadelphia, FRB New York, CBO, WSJ and Haver Analytics 16
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 17
Yield curve slope 100 basis points flatter than 2015 while dealers place highest importance on unexplained factors FACTORS BEHIND 100 BPS NARROWED SPREAD SINCE DECEMBER 2015 (bps, 30Y-2Y) Change in market implied 30Y nominal term premium 33% Other (unexplained) Change in demand for longer-dated Treasuries from liability driven investors Spillovers from foreign monetary policy Change in market expectations for the aver. effective fed funds rate over the following 2Y 66% Change in expectations for maturity distribution of Treasury issuance Change in expected net supply of Treasuries held by the public Change in estimates of the longer-run neutral real fed funds rate Change in expected U.S. inflation Change in expected U.S. economic growth 1 3 5 Importance of the factors 1 = not important 5 = very important Survey of Primary Dealers is formulated by the Trading Desk at the Federal Reserve Bank of New York. Last received date December 4, 2017 Source: BBVA Research, Federal Reserve Bank of New York and Federal Reserve Board 18
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(f) 2019(f) 2020(f) 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 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
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 21
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 22
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