The Fed Cut Cash Rates, but Where Will Long-Term Rates Go?
Last Week…
- The Fed implemented a bold half-point interest rate cut to avoid pushing the U.S. economy into a recession as inflation declines.
- Tech stocks surged, with the Nasdaq Composite gaining over 2%, as investors reacted positively to the Federal Reserve’s interest-rate cut.
- The Bank of England held its key interest rate at 5%, taking a more cautious stance than the Fed.
- U.S. home sales dropped by 2.5% in August, marking the fifth decline in six months, as mortgage rates did not sufficiently counteract high home prices.
The Fed Cut Cash Rates, but Where Will Long-Term Rates Go?
The Federal Open Market Committee (FOMC) of the Federal Reserve cut the Fed funds rate by 0.5% last week. At the current time, market participants expect the Fed to continue cutting the Fed funds rate to 3% over the next 12 months. For context, the Fed currently believes 2.9% is the “neutral” Fed funds rate (i.e. the rate that is neither restrictive nor accommodative to the economy).
If the Fed funds rate is falling, so should long-term interest rates, right? Since 1991, the 10-year Treasury bond yield has averaged 1.4% above the Fed funds rate with 1-standard deviation trading range of 1.3%. That means that if the Fed settles at 3%, a historically-reasonable range for the 10-year is 3.1%-5.7%, with a central tendency of 4.4%. While we don’t currently see 5.7% as realistic, longer-term interest rates could certainly stay at current levels, or move higher, as the Fed cuts.
Fig.1: The 10-year yield might move higher as the Fed cuts
Source: Bloomberg, Mill Creek.
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