U.S. Interest Rates Chartbook March 2018
Takeaways At the March meeting, the FOMC voted unanimously to raise the Fed funds rate to 1.5%-1.75%. The newly appointed Chairman is committed to maintaining continuity with his predecessor. On how to calibrate monetary policy when fiscal policy is expansionary, Powell stated that they are trying to take the middle ground and the committee continues to believe that the middle ground consists of further gradual increases in the federal-funds rate. Fed funds futures are pricing in two additional rate increases for 2018. The implied probability for the next rate increase in May is priced with a 64% probability. The downward pressure on term premium is resumed, as both the supply and demand imbalance in long-term Treasuries and the amplified role of duration risk as a global shock absorber remain unchanged. The yield curve slope between the 2-year and 10-year Treasury notes flattened to 48 basis points, the lowest since August 2007. The baseline remains for a gradual increase in long-term yields stabilizing at a higher rate over the forecast horizon due to higher growth, adjustment to higher inflation expectations, and higher term premium.
Unconventional monetary policy FEDERAL FUNDS RATE AND THE 10-YEAR TREASURY NOTE (%) 5.0 4.5 4.0 3.5 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 6th Rate Hike 2.5 2.0 1.5 0.5 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
FOMC 2019 and 2020 policy firming trajectory shifted upwards PROJECTED PACE OF POLICY FIRMING (%) 4.00 3.75 3.50 3.25 0 2.75 2.50 2.25 2.00 1.75 1.50 1.25 0 2018 2019 2020 Long-Run FOMC Mean, Dec. 13, 2017 (±) 2 Standard Deviation Band, Dec. 13, 2017 FOMC Mean, Mar. 21, 2018 (±) 2 Standard Deviation Band, Mar. 21, 2018 FOMC Median, Dec. 13, 2017 FOMC Median, Mar. 21, 2018 Source: BBVA Research, Federal Reserve Bank of New York and Federal Reserve Board 4
Fed funds futures are aligned with the FOMC 2018 trajectory FED FUNDS FUTURES MOST RECENT, 1 WEEK PRIOR, 1 MONTH PRIOR, 3 MONTHS PRIOR (%) 2.750 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 00 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 12/21/2017 3/1/2018 3/22/2018 3/29/2018 Source: BBVA Research and Bloomberg 5
64% probability of a seventh rate increase in May FED FUNDS FUTURES IMPLIED PROBABILITIES, SEVENTH 25BP HIKE (%) 100 90 80 70 60 50 40 30 20 10-03/01/18 03/22/18 03/29/18 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) 5.5 5.0 4.5 4.0 3.5 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 7
Baseline forecasts of treasury bill yield 3-MONTH TO 12-MONTH RATES (%) 5.5 5.0 4.5 4.0 3.5 2.5 2.0 1.5 0.5 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 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 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
Downward pressure on term premium resumes 10-YEAR U.S. TREASURY TERM PREMIUM & MARKET INFLATION EXPECTATIONS (Weekly, %) 3.5 2.5 2.0 1.5 0.5-0.5-10-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 declines to near zero DURATION-RISK COMPRESSION (Daily, %) 0.6 0.5 0.4 0.3 0.2 0.1-0.1 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 returns to negative territory DURATION-RISK COMPRESSION (Daily, %) 0.8 0.6 0.4 0.2-0.2 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
Futures discount a 4 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 (%) 3.625 3.600 3.575 3.550 3.525 3.500 3.475 3.450 3.425 3.400 3.375 Jun-18 Sep-18 Dec-18 3/1/2018 3/22/2018 3/29/2018 Source: BBVA Research and Bloomberg 13
10-year Treasury yield forecasts 10-YEAR U.S. TREASURY YIELD (%) 6.0 5.5 5.0 4.5 4.0 3.5 2.5 2.0 1.5 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 Historic Baseline Downside Risk Upside Risk NABE* (EOP, Mar. 25) SPF** (EOP, Feb. 9) Administration^ (Yr.Avg, Feb. 12) WSJ EFS^ (EOP, Mar. 1) * National Association for Business Economics (NABE) Outlook median forecast compiled from a panel of NABE members. Last release date March 25, 2018 ** Survey of Professional Forecasters (SPF) conducted by Federal Reserve Bank of Philadelphia. Last release date February 9, 2018 *** Administration: 2018 Budget. Last release date February 12, 2018 ^ Economic Forecasting Survey. The Wall Street Journal surveys a group of more than 60 economists on a monthly basis. Last release date March 1, 2018 Source: BBVA Research, FRB, NABE, FRB Philadelphia, WSJ and Haver Analytics 14
Yield curve slope forecasts TREASURY YIELD CURVE SLOPE (%, 10Y-2Y) 2.5 2.0 1.5 0.5-0.5 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 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 2.5 2.0 1.5 0.5 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 16
Treasury yield curve baseline forecasts U.S. TREASURY YIELD CURVE (%) 6.0 5.0 4.0 2.0 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 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 2.5 2.0 1.5 0.5 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 2Y 3Y 5Y 10Y 30Y Source: BBVA Research, Federal Reserve Board and Haver Analytics 18
LIBOR curve baseline forecasts U.S. DOLLAR LIBOR RATES (%) 6.0 5.5 5.0 4.5 4.0 3.5 2.5 2.0 1.5 0.5 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 1M 3M 6M 12M Source: BBVA Research, Federal Reserve Board and Haver Analytics 19
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