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Long-term interest rates remain in a narrow range. With President Trump’s deficit-widening fiscal bill working its way through Congress, Treasury investors have suddenly become nervous about the potential consequences. That, and inflation concerns provoked by tariffs, have caused long-term rates to move upwards in recent weeks, counteracting the fears of an economic slowdown that had been pushing them downward.
The potential impact of future government fiscal deficits has become a new worry for bond investors, along with the higher inflation that could be caused by tariffs. Large deficits mean that the supply of Treasury securities could, at times, be higher than investor demand for them. That would cause prices to decline and rates to rise. Whether Treasury auctions will be soft or not is usually unknowable in advance, and can catch investors unawares. The stock market also often reacts negatively when rates rise.
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Don’t count on the Federal Reserve to bail out the financial markets. The Fed now has even more reasons to not cut rates, since it is also worried about the impact of fiscal deficits on future inflation. Previously, it also stood pat because it was uncertain about the direction of the economy. At the Fed’s May 7 policy meeting, Chair Jerome Powell repeatedly emphasized how uncertain the economic outlook is, and that he wasn’t going to commit to a direction on short-term rates until the impact of recent tariffs becomes clearer. The Fed is not likely to cut rates unless there is a clear slowdown in the economy, particularly in the labor market. Investors are expecting it to cut short-term rates twice this year, but they are likely to be disappointed. The next policy meeting for the Fed is June 18.
The Fed is allowing Treasury securities to mature and run off its balance sheet at $5 billion per month. But it is running off mortgage-backed securities at $35 billion per month. The central bank would like to get non-Treasuries out of its portfolio as much as possible, in order to avoid creating unintended influences on those asset markets over the long term. The disparate treatment of the Fed’s balance sheet may keep mortgage rates elevated a bit more than usual over the 10-year Treasury note’s yield.
Mortgage rates won’t be changing much for now. If the economy weakens, then they should ease a bit. Mortgage rates are still higher than normal, relative to Treasuries, but whenever the Fed cuts short-term rates again, it will boost banks’ lending margins, which should eventually lower mortgage rates a bit, too.
Top-rated corporate bond yields have edged down in tandem with Treasury yields, but low-rated bond yields have jumped with the rise in recession fears. AAA-rated long-term corporate bonds are yielding 4.9%. BBB-rated bonds, 5.6%. CCC-rated bonds have eased to 13.0% from their 15.2% peak in April, but they are still above their early March level of 12%.
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