Rates Will Inch Up in 6 months...Watch!

The latest monthly outlook suggests no change in short rates for the next six months and only a slight increase in yield for the benchmark 10-year Treasury rate. For the time being the risks remain on the upside, however, for long rates as volatility around expectations on the dollar and Federal deficits suggest a continued cautious position on Treasuries. Fundamentals, not wishful thinking, dictate the path of interest rates.

We did have a modest economic recovery in the second half of 2009 accompanied with continued low inflation therefore, the outlook is that the Federal funds rate would be unchanged....for now!

Risk and volatility are more likely the province for longer-term Treasury rates. Here, the story is a complex mixture of economic fundamentals, policy actions and the ephemeral character of foreign investor! Economics alone would suggest a slight upward bias to Treasury rates for two reasons. First, on the demand side, investor interest suggests more risk-taking and therefore a move into corporate bonds, equities and real investment and away from Treasury debt. Meanwhile, on the supply side, Treasury issuance will continue and that increased supply, with decreased demand, suggests an upward bias in interest rates.

Given the continued low inflation one can expect a modest upswing, not a rapid rise, in rates. Volatility is a risk because both the Federal Reserve and the Obama administration will have to reveal/implement an exit strategy from stimulus. Stimulus cannot represent a permanent state of affairs.

There are three guideposts on rates.
1)First, how will the Treasury market react to the end of Fed buying?
2)Second, how will markets react to the administration’s budget message in February?
3)Finally, how will foreign investors react to recent dollar weakness, large scale defecits, and interplay of politics and economics in an election year—all this brings volatility to the markets and a busy workload for the economics department.

Thomas Ray,M.S.,Realtor
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