What Does 2016 Hold for Interest Rates?

Data source: Federal Reserve.

What bond investors think

Perhaps the best sign of confidence that interest rates aren't likely to rise at a quick pace is that interest rates on longer-term bonds haven't spiked higher in light of the recent Fed move on the shorter end of the yield curve. Typically, when bond investors expect a rapid succession of tightening moves, they push long-term rates higher in anticipation. Some policymakers note that the Fed would prefer not to have a major spike in long-term rates, as the impact on investment could pull away some potential growth-producing moves in favor of sinking money into risk-free Treasuries.

Nevertheless, it's important to note that bond investors have had a lousy track record in predicting the direction of interest rates in recent years. Consensus expectations have been for rates to rise much more quickly than the Fed eventually did, as investors apparently underestimated how patient the central bank would be in making sure it didn't commit the error of tightening too soon. The usual penalty for waiting too long is inflation, but with commodity prices still very weak, inflationary pressures don't appear imminent.

Predicting the future course of interest rates is hard even for a single year. With the Fed having communicated the likelihood of further upward moves throughout the year, it'll be interesting to see just how aggressive the Open Market Committee is in following through on its stated preference for returning monetary policy to a more normal approach this year and beyond.

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