Interest Rates: The Fed’s Inflation Fight Takes Center Stage
Kiplinger’s latest forecast on interest rates
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The Federal Reserve is expected to keep raising the federal funds interest rate by half a percentage point at its next two policy meetings. Federal Reserve Chair Jerome Powell and other board members are concerned about falling behind in their fight against inflation, and have used rhetoric suggesting that they will be aggressive in their actions the rest of this year. Powell and other Fed officials worry that the current inflation rate, at 8.3%, might cause businesses and workers to increase their expectations of future inflation, thus raising prices and wages in a self-fulfilling prophecy. Expect five more federal funds rate increases this year: Two half-point hikes and three quarter-point increases, bringing the federal funds interest rate to 2.5% by the end of the year.
The Fed will also start selling Treasury and mortgage-backed securities from its balance sheet beginning next month. The Fed will start this “quantitative tightening,” or QT, in order to pull money out of the economy as a way of dampening demand. The Fed will begin to reduce its portfolio of $9 trillion in assets by $47.5 billion per month for the three months beginning in June, and then $95 billion per month after that. It will likely have to sell some Treasury bonds and mortgage-backed securities, rather than just letting maturing bonds run off its balance sheet.
Short-term interest rates will rise along with the federal funds rate. Rates on home equity lines of credit are typically connected to the federal funds rate, and move in lock-step. Short-term consumer borrowing rates such as auto loan rates will also be affected.
Long-term rates, such as for mortgages, are not directly affected when the Fed raises short rates, but may still rise because of the current inflationary environment. Expect the Treasury 10-year yield to peak at 3.5% sometime this year, before dipping back to 3.0% by the end of 2022. The rise in the 10-year rate will also push up mortgage rates, from the current average of 5.4% for 30-year fixed-rate loans, to near 6.0%. 15-year fixed-rate mortgages will rise from 4.65% to 5.25%. It is possible that rates could ease a bit later this year if the bond market thinks that progress is being made against inflation, or if an economic slowdown persists.
Corporate high-yield bond rates have risen because of inflationary pressures and because of rising economic uncertainty. CCC-rated bond yields are at 12.6%. AAA bonds are yielding 3.7% and BBB bonds, 4.7%.
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