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The March consumer price index report was stronger than expected, sending interest rates higher, as it implied further delay before the Federal Reserve’s first interest rate cut. The lack of progress on inflation means the Fed will not be cutting interest rates until its July 31 meeting at the earliest. If the coming months’ inflation reports don’t improve, the central bank could push off any rate cuts until its Nov. 7 meeting, after the election. The Fed is probably hoping that it will be able to cut in July, because then it could follow a pattern of cutting at every other meeting, which would avoid a cut at its September 18 meeting, during the height of the presidential campaign.
There is still a decent chance of a rate cut this summer. We expect that smaller increases in rents will result in a lower inflation rate for shelter, a major component of the consumer price index. This hasn’t shown up in the CPI report yet, but it should in the near future. Still, the Fed will need to see easing inflation in the next several reports in order to justify a rate cut. While we expect that the April report will show another increase in gasoline prices, the Fed has typically discounted energy price changes. So, the key focus will be on housing and other service prices.
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Once the Fed does start cutting interest rates, it will likely continue through 2025, but will not return short-term rates to zero. Figure on the one-month Treasury bill’s yield falling to about 3%, and the bank prime rate ending up around 6%, down from the current 8.5%, after the Fed is finished reducing its benchmark rate.
The Fed could start slowing the rate of reduction in its Treasury securities portfolio at its next meeting on May 1. This would be seen by markets as an initial step toward easing overall monetary policy. This step has been expected for a while, but Powell used the word “soon” at his press conference on March 20. The Fed would effectively increase the number of maturing Treasury securities it purchases as existing bonds mature and roll off its balance sheet. Powell emphasized that it is still the Fed’s goal to reduce the overall amount of Treasuries and mortgage-backed securities on its balance sheet, however. It'll just do so at a slower pace.
The yield on the 10-year Treasury note has risen to near 4.6% but could drift down again whenever monthly inflation reports improve. Until that happens, yields are likely to stay elevated in the mid-to-upper 4s because coming economic reports are likely to point to improving growth.
Mortgage rates won’t be changing much, staying a smidge below 7.0% on average for 30-year fixed loans. After peaking near 8% in October, 30-year fixed-rate mortgages are averaging around 6.9%, while 15-year mortgage rates are averaging about 6.2%. Good inflation reports in the next few months could result in a decline of a few tenths of a point. Mortgage rates typically move with the 10-year Treasury note’s yield, but they are higher than normal now, relative to the Treasury yield. The recent rise in short-term rates has crimped lenders’ profit margins on long-term loans. But eventual Fed cuts in short-term rates will boost banks’ lending margins and should bring some extra reduction in mortgage rates, too.
Other short-term interest rates have risen along with the Federal Funds rate. For investors, rates on super-safe money market funds are above 5%. Rates for borrowers have ticked up, as well. Rates on home equity lines of credit are typically connected to the prime rate (now 8.5%), which in turn moves with the Federal Funds rate. Rates on short-term consumer loans such as auto notes have also been affected. Financing a new vehicle now costs around 7.4% for a six-year loan, and 11.4% for a used vehicle.
Corporate bond rates are moving with changes in long-term Treasury rates. AAA-rated bonds are now yielding around 5%, BBB bonds 5.8%, and CCC-rated bond yields around 13.4%.
Source: Federal Reserve Open Market Committee
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