Kiplinger Interest Rates Outlook: Short-Term Rates Will Decline Sometime This Year

But Fed Chair Powell promises it won’t happen at the March meeting.

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The Federal Reserve is willing to cut interest rates this year, but not just yet. Chair Jerome Powell said he and his colleagues are waiting to see if the recent hopeful inflation data is going to continue. In fact, Powell doubted that the Fed would have enough information by its next meeting on March 20 to justify a cut. That made some investors unhappy, as financial markets have been anticipating the beginning of rate cuts early this spring.

(which will be updated at the March meeting) raised the possibility of three interest rate cuts in 2024. But almost half of bond investors expect the Fed to cut six times. This seems overly optimistic. First, Powell has repeatedly stated that he is reluctant to start rate cuts until he is double-sure that inflation will hit the Fed’s 2% target and stay there – Powell really, really, does not want to have to backtrack and raise rates again later.

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Second, the U.S. presidential campaign will be going full-speed this summer and fall. Of course, the Fed will never cite politics as a factor in its decision-making, but Powell and his colleagues don’t want to be a political lightning rod, either. Typically, the Fed would only need to avoid raising rates during campaign season, but politics are now divisive enough that it will likely want to avoid cutting rates, too, in order to avoid accusations of political favoritism. Therefore, we expect the Fed to cut rates at its May 1 meeting, and possibly a second time at the June 12 meeting, but then stand pat during the July and September meetings before cutting again on Nov. 7, immediately after the election.

The Fed will likely continue cutting short-term rates through 2025 but will not return them to zero. Figure on the one-month Treasury bill rate falling to about 3%, and the bank prime rate ending up around 6%, down from the current 8.5%, after the Fed is finished reducing its benchmark rate.

10-year Treasury notes may flirt with yields in the high-3% range when the Fed starts or gets close to cutting. The 10-year’s yield has already fallen from 5% to 4% because the central bank appears to be done with rate hikes amid signs of cooling inflation and weakening in the labor market. But if long-term bond rates do fall below 4%, then they will likely rise again before the end of next year as the economy strengthens. Depending on how much GDP growth picks up, the yield on the 10-year could jump back up to 4.5% or 5.0%.

The U.S. Treasury is trying to avoid overburdening the long-term bond markets by selling more short-term Treasury bills. While this costs the Treasury money, due to the higher rates on short-term T-bills, it keeps the 10-year rate a bit lower than would otherwise be the case. That helps home and car buyers. 

Mortgage rates are coming down a little and will likely reach 6.5% by mid-year. After peaking near 8% in October, 30-year fixed rates are now around 6.7%, and 15-year fixed rates are averaging about 6.0%. Mortgage rates typically move with the 10-year Treasury note’s yield, but they are higher than normal now, relative to the Treasury yield. The recent rise in short-term rates has crimped lenders’ profit margins on long-term loans. But Fed cuts in short-term rates will boost banks’ margins and should bring some extra reduction in mortgage rates, too. 

Other short-term interest rates have risen along with the federal funds rate. For investors, rates on super-safe money market funds have risen above 5%. Rates for borrowers have ticked up, as well. Rates on home equity lines of credit are typically connected to the prime rate (now 8.5%), which in turn moves with the Federal Funds rate. Rates on short-term consumer loans such as auto notes have also been affected. Financing a new vehicle now costs around 7.4% for a six-year loan, and 11.4% for a used vehicle.

Corporate bond rates are also easing with the decline in long-term Treasury rates. Lower yields also reflect expectations for a “soft landing” of the economy, meaning slow growth without a recession but with lower inflation. AAA-rated bonds are now yielding 4.6%. BBB bonds are averaging 5.4%, and CCC-rated bond yields have come down the most at 13.1 %.

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Staff Economist, The Kiplinger Letter
David is both staff economist and reporter for The Kiplinger Letter, overseeing Kiplinger forecasts for the U.S. and world economies. Previously, he was senior principal economist in the Center for Forecasting and Modeling at IHS/GlobalInsight, and an economist in the Chief Economist's Office of the U.S. Department of Commerce. David has co-written weekly reports on economic conditions since 1992, and has forecasted GDP and its components since 1995, beating the Blue Chip Indicators forecasts two-thirds of the time. David is a Certified Business Economist as recognized by the National Association for Business Economics. He has two master's degrees and is ABD in economics from the University of North Carolina at Chapel Hill.