“Borrowers should prepare for a significant shift in the global interest rate environment in the next few years,” says a report published on Thursday by Fitch Ratings.
Specifically, the report says that Fitch expects U.S. real interest rates to increase to “levels that are more closely aligned with U.S. economic growth potential”, which would be notably higher than markets currently expect.
According to the report, Fitch sees U.S. potential real GDP growth at around 2%, implying a real Fed Funds rate of 2%. And, given the Fed’s inflation target of 2%, this would suggest a nominal Fed Funds rate of 3.5% to 4.0%, it says, once rates return to normal.
“With the Fed having now achieved its inflation and employment objectives, becoming more focused on the risk of labour market tightening and starting to discuss the unwinding of its balance sheet, we expect interest rate normalization will take place by 2020 and that the Fed Funds rate will reach 3.5% to 4%,” says Brian Coulton, chief economist at Fitch, in a statement.
The report indicates that this estimate is above the Fed’s current projection for the long term, and is also “substantially higher” than current financial market expectations. “It would also imply a sizeable upward shift in bond yields to the 4% to 5% range as long-term expectations for the Fed Funds rate adjust,” the report says.