Since the U.S. economy has been growing at a pace above what the U.S. Federal Reserve (the Fed) considers the long-term potential growth rate, we are closely following the evolution of Fed policy as economic growth slows. The Fed is expected to increase short-term interest rates on March 21, with the market projecting at least three 0.25% interest rate hikes this year. In general, rate hikes by the Fed tend to be deflationary, or at the very least, soften potential inflationary pressure and cause long-term interest rates to decline. In addition, slowing global economic growth momentum should also result in declining long-term interest rates.
During the 2000s, the 10-year Treasury yield has averaged less than nominal GDP (NGDP) growth. As we expect NGDP growth to slip back towards the 4.0% area, we think the 10-year Treasury yield will fall back to the 2.5% area (exhibit 3).
Our trigger finger is itchy as we watch the responses from the Fed and other central banks to the shifting economic environment. Our base case is that the Fed will not make a major mistake, which should allow the global economy to continue to grow. Economic growth leads to increase corporate revenue and earnings, which can ultimately support higher stock prices. We are prepared for more volatility and have shifted our Strategies to benefit from what we think will be a bumpy road to higher equity prices from here.
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