Kiplinger Interest Rates Outlook: Crosscurrents Keeping Rates in Narrow Band

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Federal Reserve Chair Jerome Powell emphasized that the Fed won’t cut rates until it has a better understanding of how higher tariffs affect longer-term inflation expectations. Because price effects from tariffs take time to work through the supply chain to the consumer, that will not be soon. Even though tariffs have not had much of an impact on inflation so far, Powell noted that all professional forecasters are saying tariffs will raise inflation this year, at least temporarily. Because of the danger that these price increases could affect longer-term inflation expectations, it is necessary to maintain a moderately restrictive monetary policy, as the Fed has been doing.

The Fed also released its new economic projections, showing that, by a 12-to-7 majority vote, the Federal Open Market Committee (FOMC) thought rates would be lower by the end of the year. About half of the committee expects two quarter-point cuts. It's worth noting, though, that seven committee members felt rates will be unchanged at the end of the year. Committee members raised their inflation projections a bit, indicating that any cut in rates would likely have to come with evidence of a slowing economy. The Fed’s next meeting is July 30.

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Long-term interest rates will remain in a narrow range. With the Fed standing pat, and with President Trump’s deficit-widening fiscal bill working its way through Congress, Treasury investors have become nervous about the potential consequences. That, and inflation concerns provoked by tariffs, have caused long-term rates to move upwards in the past month, balancing fears of an economic slowdown that had caused them to dip a bit recently.

The potential impact of future government fiscal deficits has become a new worry for bond investors. 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 bond yields 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 yields rise.

Mortgage rates won’t be changing much for now. 30-year fixed-rate mortgages are still around 6.8%, while 15-year loans are at 5.9% for borrowers with good credit. If the economy weakens, then rates 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.

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.

Top-rated corporate bond yields have also been treading water along with Treasury yields. AAA-rated long-term corporate bonds are yielding 4.9%, BBB-rated bonds are at 5.4%, and CCC-rated bonds have eased to 13.1% from their 15.2% peak in April on reduced recession fears. But they are still above their early March level of 12%.

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