After the Fed’s meeting last week, where they continued to signal a 3rd rate increase this year, the market immediately reacted and now believe it will actually happen in December. Fed funds futures indicate a 66% chance of a rate increase in December. Given that these odds have always been above 50% when the fed has raised rates, the door is wide open for the Fed again.
It also remains to be seen how the Fed’s decision to begin reducing its balance sheet in October will affect market rates. The overwhelming conscientious is that the curve needs to be steeper. With only 100 basis points between the overnight rate and the 10-year treasury, and the prospect of the Fed reducing that to 75 basis points in December, the curve will become very flat unless the long end can move back into a higher range. There is some believe that the reduction of the balance sheet may help with this.
North Korea continues to dominate the political news, a least in terms of the news that has any felt impact upon the market. As this situation escalates slowly, it has kept renewed pressure on rates, preventing them from drifting higher. The other major factor in recent weeks has been the combination of hurricanes Harvey, Irma, and Maria. As these three storms left plenty of devastation in areas such as Houston, the Keys, and Puerto Rico, we are still waiting to feel the economic effect.
As for the 10-year rate projection, we continue to trade right in the middle of a range roughly from 2.10% to 2.40%. We expect a 25 basis point rate increase in December, and will also hopefully have more clarity regarding the Fed’s reduction in the balance sheet by then as well.
Eric Swanson, CFA