Each quarter, lead portfolio managers and sector specialists from across our Global Fixed Income, Currency & Commodities (GFICC) platform gather at our Investment Quarterly (IQ) meeting to provide valuable insight into their sectors, debate factors likely to influence the markets over the coming quarters, and establish themes that will guide our investment strategies. One of the outcomes from the December IQ was our 2018 interest rate forecast that was higher than both forward rates and Fed projections. So far this year interest rates have moved quickly towards our expectations and events we flagged as significant watch-list items back then warrant a refresh of our US rates outlook.
Since we met in mid-December, we have seen our “Higher rates” watch-list items flash red. Passage of the tax bill, and more recently, an agreement to lift government spending, are the most notable. Combined, these bills represent a major change in fiscal policy which raise our expectations for GDP growth in 2018 and 2019, increase cyclical inflationary pressures, and may bring forward Fed rate hikes. There is potential for additional spending on infrastructure as well. This takes place in a backdrop where wage inflation, as measured by average hourly earnings, has recently recovered from Q4 weakness. This continues the three year rising trend. Recent Fed speakers have signaled comfort with raising rates three times this year, suggesting the Fed is not jarred by the recent equity sell-off and rising volatility. This is partly due to financial conditions indices which are still signaling easy conditions.
There remain risks to lower interest rates. Q1 growth indicators such as Wednesday’s Retail Sales report could continue disappointing expectations while technical indicators suggest Treasury yields may decline in the near term. Longer term, structural inflation headwinds related to technology could pick up or other risks noted above could materialize. Our team will continue to monitor these watch-list items through our robust process to identify attractive opportunities in the Treasury market in either direction.
All that said, we are biased towards higher rates in 2018 as continuing strong growth and cyclical inflation pressures will be further supported by increased US fiscal expenditures. As a result, we are raising our year-end 2018 US forecast to include four Fed interest rate hikes this year (up from three) and to increase our expectation for 10-year Treasury yields to a 3 – 3.5% range (up by 0.25%). We will continue to discuss and debate market events in the context of our forecast as part of our globally integrated, research driven process.