Kiplinger Interest Rates Outlook: The Fed Sees Progress on Inflation

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Progress on inflation seen in May’s consumer price report should keep the 10-year Treasury rate in the lower half of the 4% range. Fed Chair Jerome Powell acknowledged the progress the May price report represented, but he was clear that the Federal Open Market Committee wasn’t convinced yet that progress toward its 2% inflation goal had been achieved. 

To justify starting to cut short rates, the Fed likely wants to see several more good price reports, and especially for continued progress to be made in reducing services prices inflation, because these tend to be harder to bring down than goods prices. The Fed also typically discounts food and energy price changes because they fluctuate so often.

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We believe that the Fed will wait until its policy meeting right after the Nov. 5 election to cut rates. If not for the presidential election, the Fed might cut rates at their September meeting, but we believe that the central bank will likely want to avoid making its first move during the middle of a presidential campaign, to avoid the appearance of favoring the current administration.

Once the Fed does start cutting interest rates, it will likely continue doing so into 2026, but will not return short-term rates to zero. Figure on the one- month Treasury bill’s yield falling to about 3.5%, and the bank prime rate ending up around 6.5%, down from the current 8.5%, after the Fed is finished reducing its benchmark rate. 

The Fed started slowing the rate of reduction in its Treasury securities portfolio at its May 1 meeting. This can be considered an initial step toward easing overall monetary policy, but it had been expected for a while. The Fed will effectively increase the number of 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 it holds, however. It'll just do so at a slower pace.

Mortgage rates won’t be changing much, staying around 7.0% on average for 30-year fixed loans, and 6.3% for 15-year mortgages. 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 Treasuries. 

The recent rise in short-term interest rates has crimped lenders’ profit margins on long-term loans. The eventual Fed cuts in short-term rates, whenever they occur, 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 consumer loans 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 vehicle now costs roughly 7.0% for a six-year loan for borrowers with good credit. 

Corporate bond rates are moving with changes in long-term Treasury rates. AAA- rated bonds are now yielding around 4.9%, BBB bonds 5.6%, and CCC-rated bond yields are around 13.8%.

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