• The US Federal Reserve ended 2016 on a hawkish note, raising rates and noting US economic strength.
• Although markets are expecting growth to accelerate in 2017, a lot remains uncertain, from fiscal policy to international relations.
• Other factors may also act as a headwind to rising US rates, such as overseas demand for US bonds.
Could both the economy and government policy be at an inflection point? The US Federal Reserve (Fed) prompted this question by raising rates in December and boosting its expectations for rate hikes in 2017. As the year begins, it’s worth reflecting not only on the Fed but also on the wider outlook for US interest rates. US economic growth could accelerate this year: consumer spending is growing at a healthy pace; manufacturing surveys, a leading indicator of the economy’s health, have ticked higher in recent months; “animal spirits” have awakened since the election, as seen in the stock market’s rise.
If optimism translates into additional economic output, both GDP growth and consumer price index inflation could move above the 2.0% to 2.5% baseline expectations. That would lead to higher bond yields and ultimately a more hawkish Fed. Short-to-intermediate US Treasury yields is now at levels not seen over the past five years.
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