If you were to ask most people if interest rates are up or down since the beginning of the year, most people would answer up. That makes sense because the news makes it sound like they are, especially in reference to the Federal Reserve and their intention to continue raising “rates.” However, when rates are considered in a broader context, the answer is not only down, but considerably down so far in 2017.
What rate are we talking about?
This is where the debate really starts; there are many different types of rates out there. The rates we talk about in the news are in regards to the Federal Reserve and are the federal funds rate and federal discount rate. These rates are determined by the Federal Reserve and not the open market. This is how they control monetary policy and involves the rates used to charge other institutions when they borrow from the Federal Reserve and each other (typically banking institutions).
The federal funds rate in 2017 has risen from 0.75% to 1.25% as of June 14 of this year and most likely will rise to 1.5% by the end of the year. The Federal Reserve continues to indicate that they will raise the federal funds rate to 2.0% in 2018 and hopefully 3.0% by 2019 which would still be below historical averages and at a far slower pace than any previous increases historically.
While this is an important rate to keep an eye on, it is not the only one. Since it is an artificial rate set by the Federal Reserve, it does not contain the same relevant information as something that is determined by the overall market participants. There are many complexities in monitoring interest rates but as you get started, the first place I would look is with the 10-year treasury rate.
The 10-year treasury rate is the rate associated with US government debt that will mature in 10 years. These treasury bonds can be traded between individuals, companies and even countries themselves. There are no restrictions on what this rate is and it is determined by what the aforementioned groups are willing to pay for the treasury bonds. This means that whatever the average rate is at a given time is an indicator of what these participants think the future will bring.
In 2017, the 10-year treasury rate started at 2.45% and by mid-March had climbed past 2.60%, fueled by expectations of government stimulus and higher inflation. However, since then, optimism has faded in the market and rates have been steadily dropping all the way down to 2.15% by the end of June.
There is still a healthy debate on where the 10-year treasury rate will end up by the end of the year. It has surprised many, including investment managers and economists, that rates have slipped down this much in a year they were expected to rise. Hopefully, we can learn a few lessons from this. The first is that even if nearly “everyone” believes something (like rates must go up), that doesn’t mean it has to happen. Second, the news can be very confusing especially regarding things that are more complex like the bond market and interest rates.