Last week, a sell-off occurred in many markets, including the US bond market. The 10-year Treasury rate rose to the highest level since January of 2014, reaching 2.85%. Stressed investors are fearing rates could move significantly higher, but plenty of evidence is absent that would support this view.
The Fed anticipates three rate hikes in 2018. For a very long time during this extended economic recovery, investors have challenged whether the Fed will reach their targets. In fact, over the past number of years, the Fed has consistently overshot the number of rate hikes it has hoped to deliver annually. Why would 2018 be any different?
We believe the Fed will fall short of reaching their target again, and the pressure and stress that might apply to longer-term rates due to Fed tightening will thus diminish. Importantly, inflation is still stuck at low levels, and very much under control. It's a risky endeavor to initiate rate increases in the face of inflation that is finding great difficulty gaining traction. The idea of inflation increasing dramatically is a real stretch. The Fed will have a hard time raising rates while inflation remains low.
Another factor likely holding the Fed at bay will be central banks across the globe that continue to reduce stimulus very modestly. Thus, the interest rate differentials between many global bond markets and the US will continue to favor the US. If rates continue to move slightly higher, they will just look more attractive to investors, not less.
So what can investors expect for rates? We believe the 10-year US Treasury can certainly rise to the 3% level from here, maybe even this week. But we think rates will have a difficult time moving higher than this, and the 3% level will begin to look quite attractive to buyers. That's a 3% credit risk-free rate. The prospects of the highest level for longer-term interest rates this year being achieved in February is quite possible, and this would surprise a lot of investors.