While short-term interest rates have fallen this year as the Federal Reserve began cutting them, long-term interest rates have risen amid economic resilience.
The yield on three-month Treasury bills has fallen 67 basis points in 2024, to 4.73%. But the 10-year Treasury yield has risen 31 basis points to 4.19%.
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Short-term rates directly reflect the Federal Reserve's rate policy. And it cut the target for the federal funds rate by 50 basis points last month to 4.75%-5%. That rate applies to overnight interbank loans. Banks lend money to each other to keep their reserves stable.
Many experts anticipate that the Federal Reserve will continue to cut rates. Interest rate futures indicate an 89% probability of a 25 basis point cut at the next central bank meeting on November 6-7. The remaining 11% see no change, according to CME FedWatch.
Here is the problem with long-term rates
Fed rate cuts tend to stimulate the economy and inflation. That's why long-term rates are rising. GDP has already grown at an annualized rate of 3% in the second quarter. And the Atlanta Federal Reserve's forecast model predicts 3.4% in the third quarter.
Harvard economist Larry Summers is one expert who believes long-term rates remain high. “Markets should get used to rates in current ranges for the foreseeable future and probably to long rates above current levels,” he said in a June 4 webinar. quoted by Bloomberg.
Related: Federal Reserve official's latest words reignite interest rate cut debate
The 10-year Treasury yield stood at 4.33% that day.
Higher long-term rates are a good thing for investors who hold bonds to maturity, because they are locking in a high rate.
If you are looking for bonds with higher interest rates than Treasuries, you might consider investment grade corporate bonds. Keep in mind that you are sacrificing some security in exchange for higher returns. A 10-year JPMorgan Chase A-minus bond yields 5.06%.
T. Rowe Price's View on Long-Term Interest Rates
Arif Husain, head of fixed income at renowned fund manager T. Rowe Price ($1.63 trillion in assets), expects long-term rates to rise soon.
“Market consensus expects the 10-year US Treasury yield to decline as the Federal Reserve begins a rate cut cycle,” he wrote in a commentary.
Related: Druckenmiller and Summers send strong messages to the Fed on interest rates
“But could a combination of factors – including fiscal largesse in an election year in the United States – push the 10-year Treasury yield up from its level near 3.80% in early October?” Your answer is yes.
Regarding fiscal policy, the budget deficit amounted to $1.8 trillion in the fiscal year (2024) that ended September 30.
“I believe the 10-year Treasury yield will test the 5.0% threshold over the next six months, steepening the yield curve,” Husain said. A steepening yield curve occurs when long-term yields rise more (or fall less) than short-term yields.
Why T. Rowe Price Sees a 5% Return
He points out three factors behind his prediction.
1. “Federal Reserve rate cuts could limit short-term Treasury bill yield increases.
2. “The current issuance of bonds by the Treasury to finance the government's deficit spending is flooding the market with new supply.” A growing supply of bonds drives down bond prices and raises yields.
3. “The Federal Reserve’s quantitative tightening has driven a large, reliable buyer of Treasuries out of the market, further skewing the balance of supply and demand in favor of higher yields.”
More economic analysis:
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- Why stocks are rising and the rally has room to continue
Quantitative tightening occurs when the Federal Reserve sells bonds on the open market, keeping the proceeds of its sales out of public circulation, thus reducing the money supply.
Husain offered his most likely economic scenario: “mid-cycle adjustment,” as he called it.
“China injects more stimulus into its economy, giving a boost to global growth,” he said. “The cloud of uncertainty around the US election is quickly dissipating, allowing the Federal Reserve to make relatively shallow rate cuts.”
Related: Veteran Fund Manager Sees a World of Hurt for stocks
