How high could US interest rates rise?

By Monday December 5th, 2016 Economy

US short term interest rates look likely to rise at the next Federal
Reserve interest rate setting meeting. In anticipation longer term
interest rates have already risen. The much followed bench mark bond
the US 10year government bond has pushed sharply through the two per
cent barrier to around the 2.3 per cent level.

We believe that in 2017 short term interest rates could rise by 75bps
from current levels i.e 25bps at the next meeting in December a
further 50bps during the course of 2017.

US government 10 year bond yields are at risk of hitting three per
cent at some stage of 2017. Longer term interest rates are much more
important for the valuation of major asset classes and hence have a
powerful impact on the direction and returns of equities and bond
markets in general.

Crucial to the financial markets sentiment will be whether the rise in
interest rates is a reflection of stronger growth or a surge in
inflation in the absence of growth. The initial rise in interest rates
witnessed in recent weeks should be seen as a positive development
reflecting the markets anticipation that a President Trump
administration will be pro-growth. However Trump’s policies are likely
to take a risk with inflation. The US economy is already operating at
close to full employment and further jobs creation may lead to higher
wage inflation.

We sense that the Federal Reserve will be prepared to take a risk with
higher inflation just to ensure that the US economy does not lurch
back into disinflation building concern about deflation.

The most likely outcome for 2017 is that short term interest rates
move up slowly and modestly whilst the US 10 year yield on may rise to
around three per cent. Investors should prepare for modest to negative
returns on bonds in 2017 and at least initially, to enjoy good gains
from equities.

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