So far, it looks like we have dodged a bullet. Since the zero lower bound probably causes distortions even in forward rates, I thought there was a chance that when the rate hike was implemented, pulling forward rate expectations up off the zero lower bound, it would be associated with a relative decline in forward rates. So, either there was no distortion as I had speculated that there might be, or the change in the distortion had been priced in before the hike announcement, or forward expectations are strong enough to counter it.
I think the next concern to watch for is the discovery process as credit markets react to the higher interest rate on reserves. If the rate hike has created a contractionary response in currency, bank credit, or excess reserve levels, we will learn this over time, and I would expect forward rates at the terminal end of the yield curve to decline. Trends in mortgage lending are probably more important than any of this.
In this graph, we can see that when the Fed backed off its rate hike plans in the first half of 2015 and the economy looked reasonably strong, the rising portion of the yield curve moved forward in time, in conjunction with expectations, and the monetary accommodation led to a general rise in the terminal end of the yield curve. I would have liked to have seen the rate hike moved back to March or June. I would hope that continued patience from the Fed would have pulled the long end of the curve up to 4% or 5%. That would be normalization, if that's what we are going for.
But, as the Fed held firm on a 2015 rate hike, the long end of the yield curve fell back to the 3% range. The confirmation of a hike pulled the short portion of the curve up slightly, but the terminal value at the long end remained around 3%. The top end hasn't moved much since early October. I think this is probably the thing to watch now, but I don't have any opinion about the direction it will go. If the Fed starts pulling in more reserves and the long end of the curve begins to fall, then that seems like a strong sign that the Fed needs to reverse the hike.
If mortgage credit expands and the long end of the curve moves up, then I think we may have recovery for an indefinite period of time.