MUSKEGO, Wis.–Can long-term rates continue to slide even lower for the remainder of 2016?
Many economists think so. In fact, some believe the 10-year Treasury note will test the levels seen in 2012, pointed out John Hickey, VP of investments for Corporate Central Credit Union.
“Does anyone remember 2012? That was the year the New York Giants beat the undefeated New England Patriots in Super Bowl XLVI, and also a time when the10-year Treasury note yield fell to under 1.50%—when the U.S. economy was fully enthralled in the second and third rounds of quantitative easing,” said Hickey.
Recent weakness in the jobs reports indicates that economic growth may be slowing down, said Hickey.
“Inflation risk is nearly non-existent giving more room for the Fed to stay on the sidelines. In fact, some analysts are calling for a fourth round of quantitative easing,” said Hickey. “If rates do grind lower for the rest of 2016, global demand will likely be a major factor as many sovereign yield curves have negative interest rates.”
U.S. Rates Attractive
In the context of spreads to other sovereign yields, U.S. rates are attractive, noted Hickey.
“For example, in Germany the yield pickup for a 10-year Treasury over a 10-year German bond was only 0.17% in 2012, versus a healthy 1.60% today,” said Hickey. “Given the generous yield enhancement that U.S. Treasuries offer to international investors, lower long-term yields are something that investors had better be prepared for.”
Hickey added that CUs should have an investment strategy but also cover all possibilities.
“Have a strategy while making sure all contingencies are covered in case things don’t go as expected,” he said. “The macroeconomic outlook changed in early 2016 in a significant way.”
Hickey reminded that sentiment at the beginning of the year was multiple rate hikes in 2016, following the Fed’s first rate increase since 2006.
John Hickey
“The overwhelming consensus was that we would witness multiple rate hikes in 2016 as interest rates begin to return to ‘normal,’ whatever that means,” said Hickey. “The economy had finally reached the coveted 5% unemployment rate, a level that many economists consider full employment and the outlook was modestly upbeat. A fresh rate hike with labor market tailwinds was expected to boost consumer confidence and drive demand for mortgages, new vehicle loans and commercial development.”
Hickey said credit Unions were being advised to maintain liquidity through prudent liability pricing and strategic borrowing because higher interest rates would cause their callable investments to extend and the prepayments on their mortgage portfolios to slow to a crawl.
“That sentiment was widespread despite the Fed making it clear in its meeting minutes that the pace of increases will be gradual and data dependent,” said Hickey. “The predictable conclusion was the Fed would behave differently this time. Seemingly, the only context many pundits sought out was the previous rate hike cycle when rates were methodically raised by 0.25% for numerous consecutive Fed meetings. Based on that observation, they concluded that gradual in today’s context must mean that the Fed will raise rates at every other, or every third meeting, instead. I believe that is how we arrived at the conclusion there would be three or four rate hikes in 2016.”
Yield Curve Down
As credit unions approach mid-year 2016, Hickey pointed out that medium- and long-term yields are down sharply from the end of 2015.
“Today, the yield curve is down sharply and federal agencies are calling notes as fast as they can reoffer them for lower rates,” he said. “Many economists expect yields to remain down and perhaps go lower in the second half of 2016. Prudent liquidity management is still called for today but for different reasons than early in the year. Balance sheet managers need to resist the temptation to stretch for yield by either extending too far or funding lower-quality loans at rates that do not truly match the risk.”
Hickey said that the good news for credit unions is that hardly anyone has raised rates on shares by 0.25% in lock step with the Fed after the December rate hike.
“That means you can enjoy some more earnings in your cash portfolio. The bad news is that any sustained loan growth that the economy may offer to the market this year will need to be earned,” he said. “Unlike the period after the credit crisis, the mega banks are not deleveraging. They have massive balance sheets and a lot of liquidity. They are eager to win back the market share they lost to credit unions since the financial crisis.”