By: Russ Kamp, Managing Director, Ryan ALM, Inc.

On October 11, 2022, I penned a blog post titled “Rates Aren’t High Yet, But They Might Get There“, in which I highlighted the fact that the 3-year Treasury yield was trading at 4.33%, the highest rate along the Treasury yield curve. I also showed that rates during the 1990s were substantially higher and that economic growth was not stalled given those higher US interest rates, as the GDP averaged more than 3.5% annualized growth.

I forecasted in the post that US interest rates at that level were not going to curtail economic growth despite the perception by many in the markets that a recession was around the corner which would lead to a Fed pivot and falling rates sooner rather than later. Not surprisingly, they haven’t! The yield on the US 3-year Treasury Note at 4.33% today is exactly where it was 7+ months ago. However, the 3-year yield is not the highest along the Treasury curve, as yields for the 1-month bills to 2-year notes are all substantially higher, with the 6-month Treasury Bill trading at a 5.41% yield (2:27 pm).

So, rates, at least on the short end of the curve have risen dramatically, with no pivot in sight! Yet, economic growth has been sustained with forecasts of 1.9% annualized growth (for Q2’23) according to the Atlanta Fed’s GDPNow modeling. That doesn’t seem recessionary. Nor does the fact that the US labor market does not show signs of cracking despite higher US rates. Yes, inflation has moderated from the peak observed last summer, but we have a long way to go until the Fed’s target of 2% has been achieved.

In testimony before Congress this morning, Fed Chairman Powell stated that most Fed Governors anticipated further interest rate increases before the end of 2023. Again, no great pivot in the forecast. Despite the higher rates, US home builders seem immune, as groundbreaking on U.S. single-family homebuilding projects surged in May by the most in more than three decades, while permits for future construction also climbed. So much for the impact of higher rates.

I’ve mentioned in many posts that I thought the investment community was anchored into believing that rates and inflation would always be low, as most participants had only experienced low levels during their careers. Furthermore, the US Federal Reserve would always be there to step into the fray when the investment environment became “messy”. We cautioned everyone not to be complacent. Each of the Ryan ALM senior fixed-income team members was in the industry during the last inflationary cycle. We know what it is like to experience rapidly rising rates in an attempt to thwart inflation. You don’t want to fight the Fed, yet that is what our current investing community has done throughout the last 15 months.

Back in October, we warned you that rates were likely to climb and that the level of rates at that time would not lead to a recession in the near future. The Federal Funds Rate currently stands at 5%-5.25% with the likelihood of rates continuing to rise. This is exceptional news for pension plan sponsors and retirees, as the cash flows from bonds can now support risk-reducing strategies that don’t force one to take unnecessary risks. Use this environment to take risks off the table. Rates are likely to rise, inflation is not likely to plummet to 2% anytime soon, the economy is not going to collapse, and the Fed is in control. Don’t ignore the Fed.