- Inflation suddenly looks like it could be making a comeback, and a very loose fiscal policy could amplify that.
- Many Wall Street commenters and even some Fed members now think the central bank could raise interest rates more quickly than expected.
- That could have a huge impact on the housing market if mortgage rates quickly rise.
It didn’t take long for rate-hike expectations to be jostled further by last week’s “monster” two-year budget bill that Congress passed with its usual gyrations, including a government mini-shutdown, and that Trump signed into law on Friday. The bill increases spending caps by $300 billion over the next two years. It includes an additional $165 billion for the Pentagon and $131 billion for non-defense programs.
The bill comes after the tax cuts slashed expected revenues by $1.5 trillion of the next ten years. So pretty soon this is starting to add up.
Going forward, the US gross national debt will likely balloon at a rate of over $1 trillion a year, every year, even during the best of times. It’s $20.5 trillion currently [update 3 hours later, after debt ceiling suspended: $20.7 trillion]. It will likely be over $21.5 trillion a year from now – and this when the US economy is expected to boom. Any downturn will cause the debt to spike.
And what will the Fed do?
Four rate hikes this year – that’s what Credit Suisse’s US economists said in a research note on Monday. Previously, they’d expected three rate hikes for 2018.
“The FOMC has already boosted their growth outlook for 2018 in light of the tax bill passed in December and we anticipate another upward revision to their growth forecast at the March meeting,” the economists wrote in the research note, according to Reuters.
“With the economy near (or above) full employment, prudent risk management suggests the Fed ought to accelerate their tightening in response to a large positive demand shock,” they said.
In this cycle, the FOMC has raised its target range for the federal funds rate only at meetings that were followed by a press conference. There are four of them this year. This would mean that the Fed would announce a rate hike during each of them.
Credit Suisse added its voice to a growing chorus. Goldman Sachs, back in November and repeated on February 1, said that the strong momentum of the economy, which is boosting wages and inflation, would push the Fed to hike rates four times in 2018. This was before the “monster” budget materialized.
On January 26, also before the budget deal was done, BNP Paribas’ chief economist cited stronger growth and inflation prospects for upping their forecast to four rate hikes in 2018.
Other voices too are now talking out loud about four rate hikes. Even at the Fed, the phrase “three or four” rate hikes for 2018 is now no longer taboo.
On February 2. San Francisco Fed President John Williams, who is being considered by the White House as Vice Chair of the Fed’s Board of Governors and is a voting member of FOMC this year, told reporters after a speech that the Fed could raise rates three or four times in 2018. “Both of those possibilities are reasonable to think about, at this point, as options,” he said.
“The expansion is proceeding at a good pace, unemployment is low, and inflation is finally headed in the right direction again,” he said. This too was before the monster budget deal.
Cleveland Fed President Loretta Mester, a voting member this year on the FOMC, said on January 18, before the budget deal was even on the horizon, that the Fed should raise interest rates “three to four” times in both 2018 and 2019. She pointed specifically at the tax cuts.
So let’s crunch the numbers for a moment.
If the Fed raises its target range for the federal funds rate four times this year – so to a range of 2.25% to 2.50% in December – and if the still relatively flat yield curve remains relatively flat without steepening, the 10-year Treasury yield would reach about 3.85% by December.
But if the yield curve steepens toward a more normal-ish slope, it would push the 10-year yield somewhere near or above 4.5% by the end of this year. And this would likely cause the 30-year fixed-rate mortgage rate for top-tier borrowers, which is currently at around 4.5%, to rise above 6%, by the end of December.
And if 2019 also sees four rate hikes, those mortgage rates are likely to climb above 7% by the end of 2019. No one is prepared for this. Four rate hikes a year don’t sound like much – until it starts adding up.