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The inflation progress shown in the May and June Consumer Price Reports should keep the 10-year Treasury yield in the upper half of the 4% to 4.5% trading range. Federal Reserve Chairman Jerome Powell acknowledged the progress shown in the May price report but made it clear that the Federal Open Market Committee is not yet convinced that progress toward the 2% inflation target has been achieved. To justify starting to lower short-term interest rates, the Fed will likely want to see continued favorable inflation reports in July and August, and in particular continued progress in containing inflation in services prices, which tend to be harder to lower than commodity prices. The Fed also typically downplays food and energy price movements because they fluctuate more frequently.
If July and August CPI figures are favorable, the Fed could begin cutting rates at its meeting on September 18. If not, the Fed is expected to wait until its policy meeting shortly after the election on November 5. The Fed will likely want to avoid making its first moves in the middle of a presidential campaign to avoid appearing to favor the current administration, but market expectations may force it to act in a way that does not appear to be deliberately waiting for political reasons.
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Once the Fed starts cutting interest rates, it will likely continue to do so through 2026, but it is unlikely to bring short-term rates back to zero. After the Fed finishes cutting its benchmark rate, the yield on the one-month Treasury note is expected to fall to about 3.5%, and the bank prime rate is expected to fall to about 6.5% from the current 8.5%.
The Fed began slowing the pace of reducing its Treasury portfolio at its May 1 meeting, effectively buying more Treasuries as existing bonds mature and come off the balance sheet, but Chairman Powell stressed that the Fed's goal remains to reduce the total amount of Treasury bonds and mortgage-backed securities it holds, though the pace will be gradual.
Mortgage rates are likely to remain stable, averaging 6.9% for 30-year loans and 6.2% for 15-year fixed loans. A more favorable inflation report this year could see a decline of around 0.2%. Mortgage rates typically move in tandem with the 10-year Treasury yield, which is currently higher than normal relative to Treasuries. The recent rise in short-term interest rates has put pressure on the profit margins of long-term lenders. If the Fed were to cut short-term rates, whenever that happens, it would increase bank lending margins and drive mortgage rates down further.
Other short-term interest rates have also risen along with the federal funds rate. Interest rates on money market funds, which are extremely safe for investors, are now above 5%. Interest rates on consumer loans have also risen. Home equity interest rates are typically tied to the prime rate (currently 8.5%), which fluctuates along with the federal funds rate. Interest rates on short-term consumer loans such as auto loans have also been affected. Currently, the cost of a six-year car loan is about 7.0% for a borrower with good credit.
Corporate bond rates fluctuate in line with changes in long-term government bond rates. Currently, AAA-rated bonds yield about 4.8%, BBB-rated bonds yield about 5.5%, and CCC-rated bonds yield about 13.6%.
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