Economic Forecasts

Interest Rates: Inflation Fears Outweigh the Fed’s Dovishness

Kiplinger’s latest forecast on interest rates

Despite the Federal Reserve’s latest commitment to low short-term interest rates and easy-money policies into 2023, long-term rates rose again on continued inflation fears. Expectations of a strong economy this year and the government’s third stimulus package are pushing up 10-year Treasury note yields. Yields have been on an uptrend ever since the second stimulus package passed in December. With razor-thin control of the Senate, plus the House of Representatives and the White House, Democrats are in a position to pass even more spending legislation, such as proposals to target infrastructure and climate change. Any boost to economic growth tends to push up interest rates, as the demand for funds grows and inflation possibly rises, as well. Larger budget deficits will also raise rates as the supply of government debt offered to investors grows. The 10-year rate is currently at 1.7%. Expect it to rise to at least 2% by the end of the year.

The rise in the 10-year rate will also push up mortgage rates, from 3.1% currently to 3.5% by the end of the year. The upward drift may cause some panic home-buying, as buyers rush to lock in a low mortgage rate, giving an extra boost to rising home prices. Rates on long-term car loans should also bump up.

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. It’ll be held constant for an extended period of time.

The Federal Reserve at its most recent FOMC meeting recommitted itself to keeping short-term interest rates near zero for the foreseeable future, which likely means into 2023 or 2024. The Fed is also continuing to purchase $80 billion of Treasury securities and $40 billion of mortgage-backed securities every month, adding to its balance sheet. The Fed is “all in” to do whatever it takes to support the economy. It has said that it will be willing to tolerate inflation above 2% for a time. That means that the Fed will not raise short-term rates even if inflation begins to pick up. But if inflation rises strongly later on, the Fed would likely respond.

Corporate high-yield bond rates have started to rise as well, after a long period of easing because of greater business confidence. CCC-rated bond yields edged up to 7.5% from 7.2% a month earlier. AAA bonds are yielding 2.1%, and BBB bonds, 2.5%.

Source: Federal Reserve Open Market Committee

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