As expected, the Federal Reserve (the Fed) voted to raise interest rates for the second time this year at their June meeting. With this increase, the Fed Funds rate (range) increased from 1.50%-1.75% to 1.75%-2.00%.  Importantly, the Fed updated its forecast for potential rate hikes for calendar year 2018 to four as the U.S. unemployment rate fell to cyclical lows while headline inflation remains above target. The Fed’s dot-plot (chart 1 below) shows that the number of Fed Governors expecting higher interest rates in 2018 increased from the previous meeting in March.  It is important to remember that the dot plot represents the individual forecast for interest rates at various future periods for the 12 members of the Federal Open Markets Committee (FOMC) as well as the seven remaining Reserve Rank presidents who are not currently voting members of the committee.  This means while each plot chart may have up to 19 dots (people may abstain and/or seats may be vacant), only 12 of the dots on each chart represent voters on the Fed Funds rate.

During his post-meeting press conference, Chairman Powell provided positive comments about the current state of the economy, noting that the recent rise in oil/gas prices has had a negligible effect on the growth trajectory. As evidence of the recent robust growth, the Atlanta Fed GDPNow model is forecasting GDP growth of nearly 4.5% in the second quarter (chart 2).  Looking out a bit further, the implied Fed Funds rate for the end of 2019 is above 2.5% (chart 3 gray line), which suggests two additional rate hikes by the end of next year.

So…..what could this mean?

  1. It’s worth keeping an eye on the yield curve. From an interest rate perspective, the short-end of the yield curve has moved higher, while the long-end has continued to flatten. The difference between the U.S. Treasury 2-year and 10-year rates is now roughly 30bps (chart 4). While still positive, you’ll notice that the curve has historically been a fairly reliable predictor of future recessions as it has inverted prior to the three previous recessions illustrated by the gray bars in chart 4. In fact, every recession in the past 60 years was preceded by a negative term spread (inverted yield curve) that occurred 6 to 24 months before the official start of the recession. While the wide timeframe between inversion and recession makes preemptive or actionable investment decisions suspect, we believe the ongoing shape of the yield curve is certainly worth monitoring.
  2. There could be global implications. The U.S. dollar has continued to strengthen relative to a basket of foreign currencies and is up nearly 8% YTD (chart 5). While some of the strength in the dollar can be attributed to the Fed’s rate hikes and the resulting demand for U.S. bonds, some of the strength may be due to the changing narrative regarding synchronous global growth. News out of Europe, Japan and China has been that these economies are showing signs of slowing as foreign central banks begin the process of winding-down their bond purchases (quantitative easing measures). As was the case in the U.S., the process of tapering could prove a delicate balancing act, especially in Europe and Japan where economic growth has remained below expectations. It will certainly be interesting to watch how the bond markets react once the European Central Bank and the Bank of Japan step aside. While Japan may be a special case (having been mired in a decades-long economic slump), countries like Spain and Italy have seen their Treasury bonds trade at yields below equivalent U.S. Treasury bonds. Should those rates rise substantially, it may place additional pressure on those economies and governments.
  3. Don’t forget emerging markets. The U.S. dollar’s strength over the first half of 2018 has also put significant pressure on EM currencies. As evidence, chart 6 illustrates that EM local currency bonds (blue shaded area) have sold off as the U.S. dollar has strengthened (green line). In fact, the U.S. dollar is near all-time highs against the Argentine peso, Brazilian real and Turkish lira (see charts 7-9). From a review of the economic data, it appears the fundamentals remain largely intact for EM countries. Further, given the growth expectations in the U.S., growth in these EM countries could benefit from increased export activity. As we have reviewed, the potential impact of rising U.S. interest rates and the changing slope of the U.S. yield curve have far-reaching investment and economic implications across the globe that extend well beyond the bond market.


Chart 1: Fed Dot Plots


Chart 2: US GDP Forecast

Source: Federal Reserve Bank of Atlanta

Chart 3: Implied Fed Funds


Chart 4: US Treasury 10-Year minus 2-Year and Fed Funds

Source: Federal Reserve Bank of St. Louis

Chart 5: US dollar

Used with permission of Bloomberg Finance L.P.

Chart 6: US dollar versus emerging market local currencies

Used with permission of Bloomberg Finance L.P.

Chart 7: US dollar versus Argentine peso

Used with permission of Bloomberg Finance L.P.

Chart 8: US dollar versus Brazilian real

Used with permission of Bloomberg Finance L.P.

Chart 9: US dollar versus Turkish lira

Used with permission of Bloomberg Finance L.P.



Chart 1: Fed Dot Plot,

Chart 2: GDP Forecast, Federal Reserve Bank of Atlanta,

Chart 3: Implied Fed Funds,

Chart 4: US Treasury 10-Year minus 2-Year and Fed Funds, Federal Reserve Bank of St. Louis,


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