We are so impatient. The first intrest rate hike in almost 10 years is now hours old, and we want to know what’s next.
The first part of the answer is easy. Unlike candidates for President, or any political office, or relatives, co-workers, or salespeople, the Federal Reserve intends to do what it says it will do. It may have to change its mind, but its intentions are clear.
Every 90 days, the Fed publishes a scattergram showing where it expects to take the Fed funds rate at the end of each year in the future — today’s newest is below.
“The Fed” is the Chair, five governors nominated by the President and confirmed by Congress, and the 12 presidents of the Fed’s regional banks. There’s one dot in the scattergram for each of those officials; the dots are anonymous.
The Chair and the governors really run the show, those six voting at every meeting — only five of the regionals allowed at any one time, rotating.
Important: the regional presidents are more conservative than the others, and in every scattergram, we can safely assume that the highest four dots are crackpots, not representative forecasts.
This new set of dots says the Fed funds interest rate will be about 1.25 percent at the end of next year — three hikes in 2016 — then perhaps 2.25 percent at the end of 2017, and by the end of 2018 normalizing somewhere just above 3.00 percent. Only 18 months ago, the dots had “normal” at 4.00 percent or higher.
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Among bond market professionals, the scattergram is known as the “Damned Little Dots.” Going back four years, the dots have been much more aggressive than actual action because the Fed’s forecasts have been bad — unprecedentedly so. They’ve not been so bad at gross domestic product (GDP), only a little high, but they’ve been way high in forecasting inflation.
The Fed can hike as-forecast through 2016 without doing any harm to mortgage rates. The spread between the Fed’s overnight rate and long-term rates is very wide, and it can close by short-term rates coming up toward unchanged long-term. We and the Fed both will react to rising inflation, the Fed and markets raising rates faster and higher.
Off in the land of opinion, and in full knowledge that for financial markets, two years in the future cannot be known, the one thing I feel certain of: Events overseas will be most important to the Fed’s future.
Short- and intermediate-term rates in Europe are below zero, and there is no sign of recovery. Emerging nations are tangled in a commodity bust, which exposes their debt loads — far too high. Black-box China looks like a deflation machine. All conspiring to hold down rates, perhaps to slow the Fed’s march to wherever normal may lie.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
