Our models for employment growth, wage and consumer inflation and real GDP growth are sufficiently resilient over the coming two years that they may encourage another four 25-bps interest rate hikes from the Federal Open Market Committee, while lifting the yield on the 10-year Treasury Note towards 2.65 percent.
Our models baseline forecast points to a somewhat steady grind higher in interest rates, but, typically, such interest rates re-pricing adjustments occur more rapidly – once traders and investors agree upon the appropriate interest rate level.
Looking out into 2017, our models forecast a +2.50 percent year-on-year reading for headline CPI index before May 2017, while the core CPI index may average near +2.20 percent year-on-year over 2017.
Wage growth, which was benign for years over 2010 through 2016, may strengthen further, towards +3.15 percent to 3.45 percent within 15-18 months.
Should our wage growth forecast for 2017-2018 prove accurate, then consumer inflation may rise to +2.25 percent in early 2018—exceeding the FOMC’s +2 percent target.
The FOMC cannot be “passive” nor dovish in such an environment, and we expect the Committee to embark upon four additional interest rate hikes of 25 basis points each by 4Q-2018.
Higher yields will be a bonus for fixed income investors around the world.
Looking ahead to 2017-2019, much uncertainty may emanate from the Trump administration’s policies.
Clearly, anti-trade and anti-immigration policies hurt both the US and foreign nations who trade with America.
It is unclear just how hard Mr. Trump will press for policy change—although his rhetoric has been strong.
Mr. Trump’s ultimate policy proposals may be influenced by his Cabinet—where he is strongly reaching out to the business community.
In this way, Mr. Trump may have some very important, temperate, business opinions within his closest inner circle—we can only hope for that. (John Herrmann is Director of Interest Rate Strategy, MUFG Securities Americas, Inc.)