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Interest Rates Outlook – Q3 2019

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    The argument for lower rates has regained strength. The U.S. 10-year Treasury yield, for example, once seemed destined to climb higher and higher as U.S. economic growth was “solid.” After reaching a high of 3.2% back in October, the 10-year has surprisingly reversed course to levels last reached in 2016. Geopolitical uncertainties and slowing global growth are key culprits behind the moves. Policy makers have downgraded their macroeconomic assessments and updated their official statements to indicate the possibility for more rate reductions ahead.

    U.S. Gross Domestic Product (GDP) once trended north of 3%. At one point, not one single economist predicted the 10-year yield would fall to around 2.00%. Since then, economic data has turned mixed, and the Treasury yield curve has even inverted – inviting recession fears, intensifying haven flows, and therefore, lower yields.

    Corporations are facing strong headwinds from political developments. President Donald Trump and China’s Xi Jinping have escalated threats on one another and caused global supply chains to congest. BREXIT headlines are holding back growth by stalling decisions on long-term capital spending plans. As a result, global manufacturing activity, which can prove useful in forecasting profits, has deteriorated to contracting levels.

    Major central banks are now feeling pressure to offer fresh support. Earlier this year, the U.S. Federal Reserve guided for a “patient” stand on economic data to confirm the need for any future rate hikes. The tone now suggests the committee is shifting the other way. Members of the central bank downgraded their assessment of U.S. economic growth to “moderate” from “solid.” Additionally, per Powell, “My colleagues and I have one overarching goal, to sustain the economic expansion.” The implication is U.S. monetary officials stand ready to lend further support if needed. The European Central Bank has also expressed their intentions to take rates deep into negative territory for similar reasons.

    The consensus currently predicts the fed will lower rates by .25% at their next meeting in July. Furthermore, rate trades are forecasting additional cuts by year end, with a couple more by the end of next year. To them, concerns over recession are growing, necessitating significant “insurance cuts” today. Of course, Powell and company still cite the economy as OK, and the latest jobs data reaffirmed their position – creating some pause to market hopes. 

    US Gov Generic 10 year. interest rates.

    We think the reality is likely more in the middle. The global economy has in fact hit a rough patch, and likely could require some additional relief. However, the aggressive cut schedule fed fund futures are pricing seems a bit premature.   

    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 4th quarter of 2019 will be 2.75% based on the past performance of the 30-year Treasury rates, and we now know the third quarter discount rate was also 2.75%. 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.

    As long as we maintain an average below 2.76% for the quarter, then the ExxonMobil discount factor will round down to 2.50%…right now we are at 2.656%. For planning purposes, we believe the first quarter discount rate will drop down to 2.50%.

    Just as a little extra data, here is the ExxonMobil Discount factor for the grandfathered category going back to 2015:

    Exxonmobil chart interest rates

    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 DECREASE in the discount rates for “nongrandfathered” category from third quarter to fourth quarter of about .36 to .32 basis points.  For planning purposes, we are seeing the segments moving down further for the first quarter as well, although the numbers that drive the discount rates used are solely based off of August and September interest rate activity.

    More exxonmobil info in a chart

    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

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