Interest Rates Outlook: Powell Remains Optimistic, but Cautious
Fed Chair Jerome Powell sounded a bit less dour at his May 1 press conference, which had a brief but positive effect on financial markets. However, he also didn’t suggest an interest rate cut might happen anytime soon.
We expect the Fed to push off any rate cuts until its Nov. 7 meeting, after the presidential election. (The Fed would likely want to avoid taking any action at its Sept. 18 meeting, during the height of the campaign.) To justify a cut, the Fed wants to first see easing in the services components of the price indices, because these tend to be harder to slow than goods prices. The Fed also typically discounts food and energy price changes because they fluctuate so often.
Once the Fed does start cutting interest rates, it will likely continue doing so into 2026, but will not return short-term rates to zero. Figure on the one- month Treasury bill’s yield falling to about 3.5%, and the bank prime rate ending up around 6.5%, down from the current 8.5%, after the Fed is finished reducing its benchmark rate.
The Fed started slowing the rate of reduction in its Treasury securities portfolio at its May 1 meeting. This can be considered an initial step toward easing overall monetary policy, but it had been expected for a while.
The Fed will effectively increase the number of maturing Treasury securities it purchases as existing bonds mature and roll off its balance sheet. Powell emphasized that it is still the Fed’s goal to reduce the overall amount of Treasuries and mortgage-backed securities it holds, however. It’ll just do so at a slower pace.
The yield on the 10-year Treasury note edged down to near 4.6%, after ticking up to 4.7%. It remains highly sensitive to inflation reports. Until inflation resumes its downward trend, yields are likely to stay elevated in the mid- to-upper 4s.
Mortgage rates won’t be changing much, staying a smidge above 7.0% on average for 30-year fixed loans. After peaking near 8% in October, 30-year fixed-rate mortgages are averaging around 7.2%, while 15-year mortgage rates are averaging about 6.4%. Good inflation reports in the next few months could result in a decline of a few tenths of a point.
Mortgage rates typically move with the 10-year Treasury note’s yield, but they are higher than normal now, relative to Treasuries. The recent rise in short-term rates has crimped lenders’ profit margins on long-term loans. The eventual Fed cuts in short-term rates, whenever they occur, will boost banks’ lending 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 are 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.
-Courtesy of Kiplinger
