US Economy and Rates Update March 5, 2019

Posted April 13, 2019

Key Highlights

The US is moving through the trough in GDP growth now, with 1Q tracking at just 0.5%. Thereafter, a sizeable rebound to 2.3% in 2Q is then followed by average growth of 2.1% in the back half of the year.
The Fed has set a high bar for hiking and average growth of 1.4% in 1H19 is not strong enough to convince the Fed that inflationary pressures will rise. Above-trend growth in 2H19 and core inflation rising above its forecast prompt the Fed to hike in December.
Steady inflation then keeps the Fed on hold in early 2020. Only by mid-year is inflation accelerating more noticeably, driving further rate hikes in June, September, and December.

US Rates Strategy

A Fed on hold and subdued inflation through most of the year will make it difficult for Treasury yields to rise: Without the two hikes our economists and the median FOMC participant were projecting by December, Treasury yields should fall a bit further than we expected previously, while the yield curve should be a bit steeper. We forecast the 10y yield to end the year at 2.35% from 2.45% previously.
We think the degree of growth our economists forecast (2H19: 2.1%) will not be enough to justify the hike in investors’ eyes. Also, if the Fed begins to hike at the first signs of inflation moving above its 2% goal, investors will discount the Fed’s commitment to its symmetric inflation goal, especially if growth is near its vision of potential.
With our economists suggesting even more patience from the Fed, we think real rates will come down further. We see 10y real rates ending 2019 at 45bp, moving towards levels last seen in 2017 before fiscal stimulus had been put into place.