Economic Forecasts

Interest Rates: Long-Expected Fed Taper Coming in November

Kiplinger’s latest forecast on interest rates

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The Federal Reserve signaled that it is ready to start tapering its purchases of Treasuries and mortgage securities after its next meeting on Nov. 3. The Fed is currently purchasing $80 billion of Treasury securities and $40 billion of mortgage-backed securities every month. Expect it to begin reducing its purchases by $10 billion of Treasuries and $5 billion of MBS every six weeks at its FOMC meetings. If this is the pace, the tapering would conclude by the end of next September. Given that the Fed will not raise rates while it is tapering, it is possible that it could begin to raise interest rates at the end of next year if it feels that inflation is running too hot. But…

Chair Jerome Powell has said that the Fed would consider any spike in inflation this year to be temporary. That means that the Fed does not want to raise short-term rates in the near future, even if inflation stays high. It remains focused on its goal of seeing a lower unemployment rate and a full recovery in the labor market. But it is possible that Powell could find himself in the minority on the Fed’s FOMC policy-making committee if inflation is still stubbornly high by next fall.

Short-term consumer loan rates such as home equity lines of credit will stay where they are for most of next year. These only rise when the Fed raises its rates.

The current surge in COVID-19 infections caused by the Delta variant is keeping long-term interest rates lower than they would be otherwise, because of concerns about the effect on the economy. But the infection surge is starting to diminish, so rates should drift upward again as the economy rebounds. They have already edged up a bit.

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 2.9% currently to 3.3% by early next year. Rates on long-term car loans should also bump up.

Yet, investors in long-term bonds do not appear very concerned for now about inflation or government debt. 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.

Corporate high-yield bond rates are also staying low. CCC-rated bond yields are at 7.3%, just slightly above their recent low. AAA bonds are yielding 1.8% and BBB bonds, 2.2%.

Source: Federal Reserve Open Market Committee

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