Direction of interest rates

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
redtuna
Posts: 11
Joined: Thu Jan 02, 2014 10:34 pm

Direction of interest rates

Post by redtuna » Sat May 11, 2019 12:52 pm

I once heard that the direction of interest rates set by the Fed in the short term , 6 to 12 months, are just as hard to predict as the direction of the stock market. Is this true?

User avatar
bengal22
Posts: 1745
Joined: Sat Dec 03, 2011 6:20 pm
Location: Ohio

Re: Direction of interest rates

Post by bengal22 » Sat May 11, 2019 12:59 pm

Easy to predict; accuracy of prediction is not so easy.
"Earn All You Can; Give All You Can; Save All You Can." .... John Wesley

User avatar
Tycoon
Posts: 1500
Joined: Wed Mar 28, 2012 7:06 pm

Re: Direction of interest rates

Post by Tycoon » Sat May 11, 2019 12:59 pm

Yes, it is hard to predict interest rate direction and magnitude.
Emotionless, prognostication free investing. Ignoring the noise and economists since 1979. I see the world as it is; not how I wish it to be.

User avatar
Wiggums
Posts: 1190
Joined: Thu Jan 31, 2019 8:02 am

Re: Direction of interest rates

Post by Wiggums » Sat May 11, 2019 1:05 pm

“Fed officials say rates could shift in ‘either direction’ depending on economic growth.”

They look at many factors and each member presents their economic model. I’m sure that the fed members let the data drive their voting decisions as opposed to making decisions based on future, projected estimates.

drk
Posts: 1404
Joined: Mon Jul 24, 2017 10:33 pm
Location: Seattle

Re: Direction of interest rates

Post by drk » Sat May 11, 2019 1:25 pm

Search for the phrase “rising rate environment” on this board. As of six months ago, people were still asking whether they should move to shorter-term bond funds because of predictions about rate movements (e.g., CNBC talking head Jeff Gundlach’s predicted 4% rates).

Topic Author
redtuna
Posts: 11
Joined: Thu Jan 02, 2014 10:34 pm

Re: Direction of interest rates

Post by redtuna » Sun May 12, 2019 12:05 am

I remember watching Wall Street Week in the mid nineties. My assumption was that a strong job growth would send stock prices up. Well one Friday the monthly jobs report number was weak maybe 30,000 jobs were added. The Dow Jones jumped a few hundred points. The reason the market went up according to Louis Rukheyser was weak job numbers mean the Fed will not raise interest rates. Conclusion: what investors think the direction of interest rates will go will send the market up or down, not job growth.

AlohaJoe
Posts: 4660
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: Direction of interest rates

Post by AlohaJoe » Sun May 12, 2019 12:11 am

Image

This chart shows the history of forecasts and actual rates.

Basically, no matter what is happening people forecast that rates will shortly stablilize and "return to normal" though what people think of as normal has slipped lower over time.

Prahasaurus
Posts: 146
Joined: Fri Mar 29, 2019 1:02 am

Re: Direction of interest rates

Post by Prahasaurus » Sun May 12, 2019 12:48 am

AlohaJoe wrote:
Sun May 12, 2019 12:11 am
Image

This chart shows the history of forecasts and actual rates.

Basically, no matter what is happening people forecast that rates will shortly stablilize and "return to normal" though what people think of as normal has slipped lower over time.
Fascinating chart, thanks!

User avatar
celia
Posts: 9507
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Direction of interest rates

Post by celia » Sun May 12, 2019 3:53 am

It wasn't hard, at all, to predict the direction interest rates would go when they were close to zero.

There was nowhere to go, but up!

User avatar
Wiggums
Posts: 1190
Joined: Thu Jan 31, 2019 8:02 am

Re: Direction of interest rates

Post by Wiggums » Sun May 12, 2019 4:50 am

celia wrote:
Sun May 12, 2019 3:53 am
It wasn't hard, at all, to predict the direction interest rates would go when they were close to zero.

There was nowhere to go, but up!
+1
And it’s doesn’t hurt to have jay powell get on tv and say that the fed is going to 2%. :-)

22twain
Posts: 1952
Joined: Thu May 10, 2012 5:42 pm

Re: Direction of interest rates

Post by 22twain » Sun May 12, 2019 7:04 am

celia wrote:
Sun May 12, 2019 3:53 am
It wasn't hard, at all, to predict the direction interest rates would go when they were close to zero.

There was nowhere to go, but up!
Tell that to people in Europe and Japan. :wink:
My investing princiPLEs do not include absolutely preserving princiPAL.

petulant
Posts: 615
Joined: Thu Sep 22, 2016 1:09 pm

Re: Direction of interest rates

Post by petulant » Sun May 12, 2019 8:38 am

The issue with the question is that there are really two interest rates* worth talking about: short-term interest rates and long-term interest rates. Very similar securities, like U.S. Treasury securities, may nevertheless be very different because they may only include either short-term interest rates or long-term interest rates.

Long-term interest rates are very difficult to predict. There is a global market for long-term bonds with numerous buyers who have legally mandated objectives and sometimes non-portfolio-based objectives. For example, certain pension funds, insurance companies, and banks may purchase large portfolios of long-term bonds because they can only hold certain securities. Or, central banks for developing countries may purchase large numbers of long-term bonds to ensure the stability of their currency. It can depend. The long-term interest rate environment is difficult to predict and understand.

The Fed also has a limited ability to control the long-term interest rate. It has basically used two tools over the last ten years: short-term rates and quantitative easing. Short-term rates were thought to exert influence on long-term rates through the normal operation of the yield curve. In other words, if the Fed wants long-term rates to go down, it can bring short-term rates to near-zero, leading investors to buy more long-term assets. Going in the other direction, if it raises short-term rates, investors may view long-term assets less favorably, drawing down prices and therefore pushing yields and rates up. This relationship has not worked as expected. Most, but not all, of the embarassing predictions involve this tool not working effectively. Despite the Fed raising the Federal funds rate several times from 2016 to 2018, the interest rates on 10-year and 30-year Treasury securities actually fell during those years--for example, the December 16, 2016 yield for 30-year treasuries was 3.19, while on May 10, 2019 it was 2.89. Part of this might be explained by the efficient markets hypothesis--if it's clear based on policies and models that the Fed will be raising short-term rates, many potential investors in long-term securities may have already priced that risk into prevailing market yields. Since it was no revelation that the Fed would raise rates starting in 2016, of course the long-term rates weren't going to respond in lock-step: they already had. From December 2014 to December 2016, rates rose from about 2.75 to about 3.19.

The second tool, quantitative easing (QE), probably did have an effect on long-term interest rates, but the key type of assets affected were mortgage-backed securities (MBS). The result was that mortgage rates were much lower than you would expect based on just having had a real estate crisis. The MBS market is itself complex, however. Despite most mortgages being 15-year or 30-year mortgages, the actual duration of a mortgage is much shorter--I don't have a strong statistic, but I seem to recall it being about 7 years. There is a probability borrowers will prepay either due to a refinance or simply selling the house and moving. There is also an issue that many of the purchasers of MBS are highly leveraged. They typically use shorter-term interest rates to finance MBS and earn a profit on the spread. This includes banks who hold MBS as part of their portfolio as well as mortgage REITs and hedge funds. Increases in short-term rates can result in some of those buyers leaving the market or requiring higher MBS yields. On the other hand, if long-term rates fall, yield seekers can still go in and buy MBS. Further, since there's a finite supply of possible home buyers, the yields can move around that way. So mortgages interact with both the long-term rate market but also the short-term rate market.

Now, short-term rates are a different animal because the Fed is able to exert a strong influence on them through the Federal funds rate and open market transactions. I think movements in the short-term rates are not perfectly predictable, but they are easier to understand and predict. Thus, it was absolutely predictable that the Fed would start raising short-term rates a couple years ago because 1) they said they were going to do so, 2) inflation was creeping up to the 2 percent mark, 3) unemployment was low, and 4) economic growth was improving. And as I understand it, all of the votes to raise rates over the last couple years were unanimous. If you have some understanding of macroeconomics, you would have understood what would influence the Fed and would not be surprised. They were going to do it. However, that doesn't mean somebody can take ambiguous signals and predict the Fed's actions. For example, now inflation remains lackluster despite high job growth, the yield curve has flirted with being inverted, and tapering the asset purchases from QE has been awkward. These are mixed signals and it shouldn't be surprising the Fed's votes are not unanimous. Nobody should predict their choices with any certainty.

So, generally, if you know QE is ending and the Fed is also about to start letting MBS move off its balance sheet, it's probably fair that there will be an increase in mortgage interest rates in the short run. Beyond that, it can be tough. If you see all the inputs to basic Fed macroeconomic models saying interest rates should go up, you can bet short-term rates will go up in the short run. But you can't assume long-term rates will follow suit in any helpful way. In other words, interest rates can be understandable and some clear signs can result in predictable outcomes, but nobody has a crystal ball on ambiguous items.

*Actually, there's a theoretically infinite number of interest rates on a yield curve, but bear with me.

jello_nailer
Posts: 62
Joined: Sun Apr 07, 2019 10:20 pm

Re: Direction of interest rates

Post by jello_nailer » Sun May 12, 2019 9:02 am

Wow, what a terrific chart. So with interest rate direction they are even better than their prediction of 12 of the last 4 recessions?

User avatar
patrick013
Posts: 2657
Joined: Mon Jul 13, 2015 7:49 pm

Re: Direction of interest rates

Post by patrick013 » Sun May 12, 2019 12:05 pm

petulant wrote:
Sun May 12, 2019 8:38 am

So, generally, if you know QE is ending and the Fed is also about to start letting MBS move off its balance sheet, it's probably fair that there will be an increase in mortgage interest rates in the short run. Beyond that, it can be tough. If you see all the inputs to basic Fed macroeconomic models saying interest rates should go up, you can bet short-term rates will go up in the short run. But you can't assume long-term rates will follow suit in any helpful way. In other words, interest rates can be understandable and some clear signs can result in predictable outcomes, but nobody has a crystal ball on ambiguous items.
I agree 99% with everything you said except for one point. If the Fed wanted spreads on 20-30 year TRSY to be higher they could certainly do so. It might be why spreads were higher before the last several months. All they have to do is sell bonds in the secondary market at a higher spread than market for several months. They could take a 3% 30 year TRSY and make it a 3.25% 30 year TRSY in just perhaps 5 months by bidding the rates up with monthly sales of just a few 100 million dollars in bonds. They rarely make this process public. So rates are currently low but the FFR still might make it to 3% this year but I doubt it. Maybe next year.
age in bonds, buy-and-hold, 10 year business cycle

alex_686
Posts: 4750
Joined: Mon Feb 09, 2015 2:39 pm

Re: Direction of interest rates

Post by alex_686 » Sun May 12, 2019 12:42 pm

bengal22 wrote:
Sat May 11, 2019 12:59 pm
Easy to predict; accuracy of prediction is not so easy.
Very easy to predict, accuracy is very high. Here is a great little tool that I am surprised nobody has pointed you to.

https://www.cmegroup.com/trading/intere ... -fomc.html

On the accuracy part, you will note that the tool does provided both a path and a probability distribution. For example, it gives a 43% probability that rates will stay the same, with a 57% chance of a ease. These distributions are pretty well calibrated and are pretty accurate.

petulant
Posts: 615
Joined: Thu Sep 22, 2016 1:09 pm

Re: Direction of interest rates

Post by petulant » Sun May 12, 2019 2:30 pm

patrick013 wrote:
Sun May 12, 2019 12:05 pm
petulant wrote:
Sun May 12, 2019 8:38 am

So, generally, if you know QE is ending and the Fed is also about to start letting MBS move off its balance sheet, it's probably fair that there will be an increase in mortgage interest rates in the short run. Beyond that, it can be tough. If you see all the inputs to basic Fed macroeconomic models saying interest rates should go up, you can bet short-term rates will go up in the short run. But you can't assume long-term rates will follow suit in any helpful way. In other words, interest rates can be understandable and some clear signs can result in predictable outcomes, but nobody has a crystal ball on ambiguous items.
I agree 99% with everything you said except for one point. If the Fed wanted spreads on 20-30 year TRSY to be higher they could certainly do so. It might be why spreads were higher before the last several months. All they have to do is sell bonds in the secondary market at a higher spread than market for several months. They could take a 3% 30 year TRSY and make it a 3.25% 30 year TRSY in just perhaps 5 months by bidding the rates up with monthly sales of just a few 100 million dollars in bonds. They rarely make this process public. So rates are currently low but the FFR still might make it to 3% this year but I doubt it. Maybe next year.
You're right--they could accomplish something like that with open market transactions, although I don't claim to know the magnitude of transactions necessary to calculate it. I think it would be more difficult for them in the long-term market than the short-term market though--the same way a central bank like BOJ or BOC can peg an exchange rate and can probably accomplish it with open market transactions, but it may be a large or costly operation.

mptfan
Posts: 5326
Joined: Mon Mar 05, 2007 9:58 am

Re: Direction of interest rates

Post by mptfan » Sun May 12, 2019 2:43 pm

redtuna wrote:
Sat May 11, 2019 12:52 pm
I once heard that the direction of interest rates set by the Fed in the short term , 6 to 12 months, are just as hard to predict as the direction of the stock market. Is this true?
No, predicting interest rates is easy, anyone can do it.

User avatar
patrick013
Posts: 2657
Joined: Mon Jul 13, 2015 7:49 pm

Re: Direction of interest rates

Post by patrick013 » Sun May 12, 2019 3:01 pm

petulant wrote:
Sun May 12, 2019 2:30 pm
patrick013 wrote:
Sun May 12, 2019 12:05 pm
petulant wrote:
Sun May 12, 2019 8:38 am

So, generally, if you know QE is ending and the Fed is also about to start letting MBS move off its balance sheet, it's probably fair that there will be an increase in mortgage interest rates in the short run. Beyond that, it can be tough. If you see all the inputs to basic Fed macroeconomic models saying interest rates should go up, you can bet short-term rates will go up in the short run. But you can't assume long-term rates will follow suit in any helpful way. In other words, interest rates can be understandable and some clear signs can result in predictable outcomes, but nobody has a crystal ball on ambiguous items.
I agree 99% with everything you said except for one point. If the Fed wanted spreads on 20-30 year TRSY to be higher they could certainly do so. It might be why spreads were higher before the last several months. All they have to do is sell bonds in the secondary market at a higher spread than market for several months. They could take a 3% 30 year TRSY and make it a 3.25% 30 year TRSY in just perhaps 5 months by bidding the rates up with monthly sales of just a few 100 million dollars in bonds. They rarely make this process public. So rates are currently low but the FFR still might make it to 3% this year but I doubt it. Maybe next year.
You're right--they could accomplish something like that with open market transactions, although I don't claim to know the magnitude of transactions necessary to calculate it. I think it would be more difficult for them in the long-term market than the short-term market though--the same way a central bank like BOJ or BOC can peg an exchange rate and can probably accomplish it with open market transactions, but it may be a large or costly operation.
I think they would need a few 100 million dollars in volume daily, or at least weekly to have any effect.

I'm just staying with my laddering I think.
age in bonds, buy-and-hold, 10 year business cycle

User avatar
vineviz
Posts: 4643
Joined: Tue May 15, 2018 1:55 pm

Re: Direction of interest rates

Post by vineviz » Sun May 12, 2019 3:18 pm

mptfan wrote:
Sun May 12, 2019 2:43 pm
redtuna wrote:
Sat May 11, 2019 12:52 pm
I once heard that the direction of interest rates set by the Fed in the short term , 6 to 12 months, are just as hard to predict as the direction of the stock market. Is this true?
No, predicting interest rates is easy, anyone can do it.
I think the implicit condition was accurately and profitably predicting interest rates.

Many people think they can do this, but we know they can’t. Not consistently, anyway.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

lack_ey
Posts: 6694
Joined: Wed Nov 19, 2014 11:55 pm

Re: Direction of interest rates

Post by lack_ey » Sun May 12, 2019 3:33 pm

Direction of short rates should not be as hard to predict as the stock market especially in the current regime with telegraphed intentions by the central banks, known mandates, etc.

Especially if we're looking say 1 month before a FOMC in the US; in the last few years there's often been a 90%+ chance (as implied by the futures market) of a certain move—up or same—and yes, the market expectation has come to fruition at a rate far higher than you'd hit if guessing blindly. Farther out, economic conditions and other input variables are more difficult to know, and uncertainty increases. But still there may be some limited predictability.

The thing is that short-term interest rates are effectively set according to desired policy, and knowing the direction (unless you know better than the market does) doesn't really give you much of an edge or way to make easy money. Stock market direction is determined by the market, and if you knew what was going to happen, you would be able to make incredible amounts of money.


Expectations of future FFR changes don't impact today's FFR target range. Expectations of future stock market changes do impact today's stock market prices.

Post Reply