Have you seen interest rates lately?
Have You Seen Interest Rates Lately? October 17, 2018 U.S. policy makers continue to press forward with gradually raising rates given healthy economic conditions. “It’s a particularly bright moment,” were Fed chairman Jerome Powell’s recent words to describe the economy. Indeed, U.S. GDP growth is on track to be a solid 2.8% this year, unemployment is low, and inflation is stable and at target.
The Federal Open Market Committee (FOMC) met recently on September 26th, and as expected, they upped their benchmark borrowing rate .25% for the third time in 2018. Rates are now set between a range of 2% to 2.25%. Additionally, remarks from the FOMC hinted to a potential fourth adjustment higher at year-end. And Powell went a step further, expressing the committee’s guidance for more increases well into 2019. The other key development was that the official statement removed references to “accommodative” policy. The Federal Reserve previously cited the phrase to comfort markets that easy conditions would remain in place even as they began policy normalization back in 2015. “This change does not signal any change in the likely path of policy,” per the Fed chairman. “We still expect, as our statement says, further gradual increases in the target range for the fed funds rate.” The implication is clear that the economy is now strong enough to stand on its own, lending support for more hikes. The quarterly updated Dot-Plots, or the Fed’s short-term rates projections, showed twelve of sixteen members see a fourth increase this year – a one member increase from the last report. As for next year, the voting body seems balanced on three total hikes.
Longer-run forecasts, however, turned a bit murkier. A few members revised lower their rate expectations for 2020, with some now anticipating rates to converge towards their longer-run estimate of 3% by 2021.
Markets remain skeptical of the FOMC’s initiatives for next year and beyond. Fed funds futures currently imply monetary policy will see two vs three total hikes in 2019. Aside from rising interest rates, Fed balance-sheet reduction, protectionist policies, strengthening U.S. Dollar and higher levels of market uncertainty are also complicating matters. The question is can these developments reach problematic levels that cause central bankers to doubt their agendas? We maintain our stand that rates are heading generally higher, but we anticipate they will move in a range bound fashion.
What are the implications for ExxonMobil households?
As many of you know, there are two categories of employees when it comes to their pension/lump-sum options. Those who were born before 1958 and hired before 1998, they take 95% of the quarterly average of the 30-year Treasury Rates, these individuals are given the title of “Grandfathered” category. For those who were born after 1957 or hired after 1997, they use a combination of short term, intermediate term, and long term corporate bond rates, and as you could guess, these individuals are considered “Non-grandfathered.”
For the grandfathered individuals, we know that the discount factor for the 1st quarter of 2019 will be 3.00% based on the past performance of the 30-year Treasury rates. This is equal to what the discount factor was in the 4th quarter of 2018. The question is, where do we go from here? If we had to make a projection on 30 year yields in the short-term, rates are likely to remain volatile as headline risk continues to influence markets, especially on light summer volumes. However, in the medium to longer-term, macroeconomic fundamentals point to higher rates as “transitory” factors should pass, global economies gain further strength and global central banks taper accommodations.
As long as we maintain an average below 3.289% for the quarter, then the ExxonMobil discount factor will stay flat at 3.0%…right now we are at 3.33%. For planning purposes, we believe the second quarter discount rate will increase .25% from 3.0% in the first quarter up to 3.25%.
Just as a little extra data, here is the ExxonMobil Discount factor for the grandfathered category going back to 2011:
For those in the “nongrandfathered” category, it is difficult to easily see the overall impact when short term rates are moving at different speeds, or even different directions. To address this, we estimate an equivalent “single rate” that makes comparison easier. In summary, there is a large rise in the discount rates for “nongrandfathered” category from first quarter to second quarter of about .16 to .17 basis points.
The pension/lump sum conversation is just one part of any household’s financial plan. We encourage all to review this in conjunction with their financial advisor. Please feel free to reach out if you have any questions.
Sincerely, Bogart Wealth