Record low long-term U.S. Treasury interest rates and economic growth.

The second quarter ended with the 10-year and 30-year U.S. Treasury yields at record lows. To put that in perspective, the U.S. Government has been issuing debt for over 220 years. The U.S. Government began issuing debt in 1790 to pay off Revolutionary War debt. The yield curve has now been flattening for well over two years. Globally, the amount of developed country sovereign debt with negative yields has continued to grow. Japan, Germany, and some other European country sovereign debt is now seeing negative yields as far out as ten years. As a result of the divergence between U.S. Treasury yields and these negative yields, many expect capital outside the U.S. to continue flowing into positive yielding U.S. Treasury bonds. In addition, given the possibility that Brexit is not the only concern in the Eurozone (or other global regions for that matter), many believe that foreign capital will continue to flow into U.S. Treasury bonds for the relative safety status as well. Will these factors continue to put downward pressure on longer-term U.S. Treasury yields? If so, for how long, and how low could they go?

Mortgage implications and considerations

If the 10-year U.S. Treasury yield remains at these levels or descends lower, many mortgage borrowers may find the refinance option now favorable to them. Looking at all outstanding mortgages, borrowers in this category represent a fairly large portion of current mortgages outstanding. Credit unions that have longer-term fixed mortgages on their balance sheet may want to assess their exposure to this possibility (i.e., prepayment acceleration). Credit unions may also want to consider strategies to take advantage of the potential to obtain refinancing business. Furthermore, the lower rates could put a new segment of consumers into the mortgage shopping category that previously may not have qualified. However, considering any type of strategy along these lines always comes with the caveat of thoroughly assessing the potential risks prior to any implementation (including if the credit union has access to sell mortgages), particularly given the current very low interest rate environment.

Economic Growth

Real GDP increased at an annual rate of 1.1% in the first quarter of 2016 according to the third estimate released by the Bureau of Economic Analysis on June 28th. Growth came from personal consumption expenditures (PCE), residential fixed investments, and state/local government spending. However, growth in PCE contributed less than previous quarters, federal government spending was down, and nonresidential fixed investment was down. The result was an annual GDP growth rate that was less than the third and fourth quarters of 2015 (3.3% and 2.3%). In the previous two years, first quarter Real GDP’s annual growth rate was the lowest of each year’s quarterly measures. Will this year be the same or will this year be different? If it is the same as previous years and growth does pick up, will the Federal Reserve continue to increase the targeted Federal Funds rate or will global concerns keep them at bay?

Federal Reserve

At the end of 2015, the Federal Reserve’s FOMC raised the target Federal Funds rate and indicated that 2016 could see four more increases. At the time we offered that other alternatives such as a much slower pace of increases or even a reversal altogether be factored into the credit union’s risk management and earnings considerations. Fast-forward to the halfway point in the year and we continue to maintain that all of these alternatives be considered in decision making. The expectation has clearly shifted to a much slower rate of increases at this time. The minutes of the June FOMC meeting cited the Brexit vote results and a slowdown in hiring as a reason to keep the targeted Federal Funds rate unchanged at that meeting. Following this FOMC meeting, Brexit concerns have seemed to subside for the moment, but other concerns of financial stability in certain regions globally remain. Domestically, June payroll growth was much better than expected and may provide some relief to the FOMC’s concern regarding employment. Given these considerations, will the FOMC resume increasing the target federal funds rate in the near term? The U.S. Treasury yield curve would not seem to indicate prolonged rate increases on the horizon. However, if economic growth accelerates from the first quarter and global concerns subside, further rate increases could well be in the cards.

In summary, as the year has progressed, the interest rate environment has become more uncertain as compared to the path put forth by the FOMC at their December 2015 meeting. As always, credit unions are encouraged to consider and assess all of the potential paths in managing interest rate risk and strategic decisions which may impact their interest rate risk profile.