Economic Forecasts

Interest Rates: Long Rates Staying Low for Now, Rising Later

Kiplinger’s latest forecast on interest rates

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The current surge in COVID-19 infections caused by the Delta variant is keeping interest rates lower than they would be otherwise, because of concerns about the effect on the economy. But the infection surge is not likely to last past September, so rates should begin to drift upwards again in the near future.

So far, investors in long-term bonds do not appear to be concerned that high inflation will last. As the economy has strengthened, shortages have developed, pushing up prices of cars, appliances, car rentals, housing, etc. While shortages will likely ease over time, government spending on infrastructure and other priorities should keep the economy running hot and apply upward pressure on yields on 10-year Treasury notes. U.S. government debt will rise to 108% of GDP this year, and 114% next year. This is uncharted territory: The highest the national debt has ever been was 106% of GDP right after World War II. Expect the 10-year yield to rise to at least 1.8% by early next year.

The rise in the 10-year rate will also push up mortgage rates, from 2.8% currently to 3.3% by early next year. Rates on long-term car loans should also bump up.

Chair Jerome Powell of the Federal Reserve has said that the Fed would consider any spike in inflation this year to be temporary. That means that the Fed will not raise short-term rates, even if inflation stays high. It remains focused on its goal of seeing a lower unemployment rate and a recovery in the labor market.

Short-term consumer loan rates such as home equity lines of credit will stay where they are. These tend to be tied to the federal funds interest rate, which is controlled by the Federal Reserve. The fed funds rate will be held steady near 0% for an extended period of time.

While the Federal Reserve is committed to keeping short-term interest rates at rock bottom for a while, watch for signs that it may begin tapering its purchases of Treasuries and other securities. The Fed is purchasing $80 billion of Treasury securities and $40 billion of mortgage-backed securities every month, adding to its balance sheet. When the Fed thinks the economy does not need this support, it will begin reducing its purchases by $10 billion of Treasuries and $5 billion of MBS every six weeks at its FOMC meetings. This will take place before the Fed raises short-term rates, since tapering its bond purchases is considered an intermediate measure.

Corporate high-yield bond rates are staying low, as the strong economy is outweighing any inflation concerns. CCC-rated bond yields are down to 6.9%, almost a record low. AAA bonds are yielding 1.8% and BBB bonds, 2.2%.

Source: Federal Reserve Open Market Committee

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