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Federal Reserve Chair Janet Yellen reiterated the Fed’s intention to raise interest rates last week. Another 25-basis-point increase in the federal funds rate is scheduled for December. The Fed will also begin to wind down its massive securities holdings.  

So, how did market participants react? 

Interest rates mostly drifted lower, particularly on the long-end of the yield curve. The yield on the 10-year U.S. Treasury note moderated. Not surprisingly, mortgage rates moderated as well.  Quotes on the 30-year fixed-rate loan were mostly flat to slightly lower. 

We mentioned last week that we wouldn’t be surprised to see interest rates and mortgage-rate quotes drift lower. The unknown keeps the trajectory going, not the known. What Yellen said was common knowledge. It was priced in the market. 

Though the Fed is determined to keep interest rates rising, consumer-price inflation has yet to cooperate. Inflation runs below the Fed’s 2% annual target rate. Inflation mostly influences the long end of the yield curve; the Fed mostly influences the short end. Despite all the talk of the Fed raising interest rates, long-term rates remain muted. 

On the short end of the yield curve, some rates have moved higher. The yield on the two-year note is near a 10-year high (but it’s still up only 10 basis points for the year). Yields on the three- and five-year notes are also up, but, again, not by much.  As for the impact on us, quotes on 5/1 ARMs remain near 2017 lows. 

Change could be in the air, though it’s change we’ve been acclimated to before. 

After the November election, interest rates spiked higher in anticipation of President-elect Trump implementing his pro-growth initiatives. So far, it has been a no go. Trump has been stonewalled to date. Nevertheless, he appears ready to give it another try. 

Trump has resurrected his tax-rate-cut agenda. Based on the scuttlebutt, Trump seeks to lower the top individual tax rate to 35% (the top rate is 39.6%). He seeks to lower the top corporate tax rate to 20% from 35%. 

The lower corporate income tax rate is key. It would be more simulative than other tax-rate reductions. The tax literature is replete with evidence that a tax on capital most impedes economic growth, much more so than taxes on labor income or on consumption (such as sales tax). Should a 20% corporate income tax prevail, Janet Yellen et al. could finally get the inflation they so desire. Interest rates would surely rise. 

We’re not there yet. President Trump has been stymied in past attempts to pass any reforming legislation. If part II plays like part I on taxes, it’s much ado about nothing. But if it plays differently with a substantial tax-rate cut on businesses, those higher interest rates everyone has expected for the past five years could finally materialize.
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