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A higher-than-expected inflation report for January spooked the bond markets and may make Federal Reserve Chair Jerome Powell cautious about cutting interest rates as soon as the May 1 Fed policy meeting. He may decide to wait until the June 12 meeting to cut. That would allow the Fed to observe four months of inflation reports instead of just two. But we think that he will still likely drop hints of an impending move at the May 1 meeting, or that he will telegraph the future Fed move by increasing the rate of replacement of maturing securities that the Fed currently owns, thus slowing the ongoing reduction in its balance sheet. We expect him to maintain a steely anti-inflation resolve at the March 20 policy meeting, however.
Normally, the Fed would want to cut rates every other meeting, but doing so for the first time in June would mean cutting a second time in September, which would make the central bank a lightning rod during the presidential campaign season, which Powell and his colleagues really want to avoid. So, the Fed may cut on June 20, July 31 and then again on November 7, immediately after the election. But no matter what the Fed does or doesn’t do, it will be accused of favoritism by one side or the other.
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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’s yield 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.
The yield on the 10-year Treasury note jumped to 4.3% on the January inflation report, but will likely drift down again a bit when the Fed signals that it is close to cutting. However, yields could stay in the mid-4s if GDP growth is stronger than expected in the first half of the year.
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-rate mortgages are averaging around 6.7%, while 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 moving with changes in long-term Treasury rates. AAA-rated bonds are now yielding 4.8%. BBB bonds are averaging 5.6%, and CCC-rated bond yields have come down the most, now averaging 13.5%.
Source: Federal Reserve Open Market Committee
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