The events of the third quarter of 2017 were full of sound and fury, but really didn’t signify much in the U.S. bond market. Interest rates on the ten-year Treasury bond began the quarter at 2.29 percent. July was flat, but August dawned to a round of North Korean sabre rattling and a series of hurricanes that had interest rates “free fallin” (as the late, great Tom Petty would’ve put it) up until Labor Day. The yield on the 10-year Treasury fell all the way down to 2.12 percent, the lowest level of the year. Then, just when the devastation of Harvey, Irma and Maria had everyone thinking we’d all be living like refugees, long term interest rates turned around and climbed back to where they began the quarter, with the 10-year Treasury yield back to 2.29 percent by the end of September.
On the short end of the spectrum, the U.S. Federal Reserve Bank did not raise rates at their September meeting, leaving the overnight lending rate in a range of 1 percent to 1.25 percent. Fed members likely won’t back down from their promise to hike rates again in December, however. They did hedge themselves a bit, with mention of the lack of inflation in the U.S. economy. Probability of another 0.25 percent increase in December, as measured by the Fed Funds futures market, is now about 90 percent. This jives with the prospect of a further uptick in economic growth during the fourth quarter, as hurricane rebuilding and ongoing improvement in business sentiment should boost both consumer and capital spending. The weaker dollar will also generally boost demand for U.S. exports.
The biggest story to emerge from the September Fed meeting was confirmation of the central bank’s plan to unwind Quantitative Easing (QE). Recall that QE involved the Fed basically creating $4 trillion in new money out of thin air in the aftermath of the financial crisis of 2008. This had the effect of driving both short- and long-term interest rates to 50-year lows, and stock prices to all-time highs. The Fed has been saying for several years that they would like to “normalize” interest rates, but we’re still waiting. As we all know, “the waiting is the hardest part.”