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Long-term interest rates jumped on evidence that more Federal Reserve Board members don’t expect to cut short-term interest rates much next year. The change in Fed expectations has to do with the improving economic outlook and the reduced chance of a recession. Stronger GDP growth so far this year has pointed to continued momentum in the economy, and the Fed is projecting GDP growth of 1.5% next year, down only a little from 2.1% growth this year, and an unemployment rate in 2024 of 4.1%, just a little above the current 3.8%.
The path of long rates will therefore depend on how much the economy slows next year. A shallow slowdown, which we expect, is likely to leave both long and short rates elevated until inflation gets near the Fed’s 2% target. Chair Powell also allowed that the long-run “neutral” policy rate (the level consistent with stable inflation) could be higher than previously expected, which would mean fewer Fed rate cuts over the long run.
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The Federal Reserve left rates alone at its policy meeting on September 20 and is likely finished raising rates for now. Chair Powell noted that there was support for one more quarter-point hike at either the November 1 or December 13 meetings, but downplayed the significance of it, indicating that what matters is how long the Fed keeps rates high. Currently, the Fed seems to be leaning towards not cutting rates at all until late next year. Chair Powell has repeatedly emphasized that it would be a mistake to cut rates too early and risk letting inflation rebound.
Other short-term interest rates have risen along with the federal funds rate. For investors, rates on super-safe money market funds have risen to around 5%. Rates for borrowers have ticked up, as well. Rates on home equity lines of credit are typically connected to the fed funds rate and move in lock-step with it. Rates on short-term consumer loans such as auto loans have also been affected. Financing a new vehicle costs around 8% for a six-year auto loan for buyers with good credit.
Mortgage rates will stay elevated until there is more progress in the inflation fight. 30-year fixed-rate mortgage loans are averaging 7.2%, roughly the same as their peak in early November, while 15-year fixed-rate loans are around 6.5%. Mortgage rates react to changes in the 10-year Treasury yield, though they are going to stay a full percentage point higher than the 10-year Treasury yield because lenders’ cost of funds has risen with short rates while long rates have risen less, which has squeezed lenders’ margins.
A better economic outlook has caused rates on AAA and BBB corporate bond rates to rise a bit, but less so for CCC bonds. Higher-rated bond yields are ticking up a bit on expectations of a better economy and stronger inflation, but lower-rated bond prices have not declined as much, as fears of a pickup in bankruptcies ease. (Rising prices of bonds result in their yields falling.) AAA bonds are now yielding 5.1% and BBB bonds, 6.2%, while CCC-rated bond yields are at 13.5%.
Source: Federal Reserve Open Market Committee
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