2019 Interest Rate Outlook

A confluence of events is setting up an uncommon and interesting year for interest rates.

Robert Spendlove Jan 14, 2019

For most of 2018 interest rates were on the rise. With the crisis-era mentality fading, the Federal Reserve increased the federal funds rate (its primary policy tool) four times to a range between 2.25 – 2.50 percent. The Fed has been steadily hiking interest rates as way to stay ahead of potential inflationary pressures emerging from the labor market.

With the unemployment rate below four percent, the Fed has been concerned that heightened competition for labor would lead employers to rapidly lift wages. This could lead to higher prices and greater inflation throughout the entire economy.

For most of the year, long-term rates were on the rise as well. The yield on the 10-year U.S. Treasury note hit a seven-year high of 3.26 percent in November.

However, in the last months of 2018, growing concerns over the health of the economy, both in the U.S. and abroad, have sent long-term interest rates tumbling. 

Understanding the drivers for short-term and long-term rates

Short-term and long-term interest rates are influenced by different economic factors.

Short-term interest rates are primarily driven by the Federal Reserve’s policy decisions and its targeting of the federal funds rate.

When the Fed wants to moderate economic growth and dampen inflationary pressures, it raises the target for the federal funds rate. When it wants to stimulate economic activity, it lowers the target.

These actions directly affect short-term borrowing rates on products such as credit cards, home equity loans, and car loans, but they also affect savers as well. When short-term interest rates are low, as they have been for the past decade, individuals who hold cash or cash-similar investments are disadvantaged. When short-term rates rise, these savers typically benefit.

Long-term interest rates are primarily influenced by the overall health of the economy, both in the U.S. and abroad. The main rate to watch is the yield on the 10-year U.S. Treasury note, which often drives mortgage rates as well.

When the U.S. economy is strong compared to the rest of the world — which has been the case recently — investors from abroad flock to the 10-year note because it is guaranteed by the U.S. government.

Additionally, 10-year notes act as a safe haven for investors in the U.S. when conditions make equity markets and riskier assets unattractive.

In both cases, when investors buy notes (or bonds) it pushes up the price and lowers the yield (note prices and yields move inversely). With both global economic conditions deteriorating and volatile equity markets at home, the yield on the 10-year Treasury note has plummeted as more and more investors seek a safer place to wait out the storm.

The Fed’s interest rate path is far from certain

For most of 2018 it was predicted that the Fed would continue raising interest rates into 2019, perhaps three or four times. However, due to deteriorating global economic conditions, lingering trade issues with China, and high volatility in equity markets, that rate path is unlikely.

At the Fed’s most recent meeting in December, its projections pointed to two interest rate increases in 2019. But, recent comments by Fed Chair Powell bring even that projection into doubt. Somewhat surprisingly, some traders are predicting that the Fed may not raise rates at all in 2019, and even leave open the possibility that the Fed will cut rates.

While it is possible that the Fed will forgo any interest rate hikes in 2019, it is not the baseline scenario. The Fed will be keeping a very close eye on the labor market, which has continued to prove resilient in the face of current uncertainty.

The U.S. economy added a better-than-expected 312,000 jobs in December and annual wage growth improved to 3.2 percent. If this trend continues, then two quarter-point rate increases in 2019 are a likely scenario.

Interest rates could be favorable to both savers and borrowers in 2019

A confluence of events is setting up an uncommon and interesting year for interest rates. On the one hand, the Federal Reserve may raise short-term rates twice in 2019. This bodes well for savers and retirees, as more and more banks are competing for deposits and are starting to boost rates on interest-bearing accounts.

 At the same time, global economic growth is slowing, and the lingering trade spat with China and the Fed’s own interest rate policy are casting doubt on the health of the U.S. economy, causing long-term rates to fall.

If these dynamics continue, savers will be rewarded for holding cash, and longer-term borrowers — such as homebuyers — will benefit from lower interest rates.

Content is offered for informational purposes only and should not be construed as tax, legal, financial or business advice. Please contact a professional about your specific needs and advice. Content may contain trademarks or trade names owned by parties who are not affiliated with Zions Bancorporation, N.A. Use of such marks does not imply any sponsorship by or affiliation with third parties, and Zions Bancorporation, N.A. does not claim any ownership of or make representations about products and services offered under or associated with such marks.

Robert Spendlove is Economic and Public Policy Officer for Zions Bank and a member of the Utah House of Representatives representing District 49. 

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