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The 10-year Treasury yield ticked up to 4.4% following the election on investor nervousness about federal fiscal deficits getting worse. The Congressional Budget Office has estimated deficits will average 6% of GDP over the next 10 years under existing tax and spending laws. That doesn’t include the extension of the 2017 Tax Cuts and Jobs Act, which will definitely happen under a Republican Congress and administration. President-elect Trump has also made campaign promises of various other tax cuts that he would enact in a second term. All of these could boost both GDP growth and inflation, and cause the Federal Reserve to cut short-term interest rates slower than markets were expecting. The realities of governing after the election could mean that many of these campaign promises will go unfulfilled, but you should expect long-term interest rates to stay above 4.0% until it becomes clearer what legislation will actually pass.
Expect the Federal Reserve to continue cutting short-term interest rates, for now. The Fed cut rates by a quarter-point at their Nov, 7 policy meeting, and another quarter-point cut seems likely at the Dec. 18 meeting. Chair Powell emphasized at his post-meeting press conference that he is committed to reacting to incoming economic data, and not to speculation about what has been proposed by Trump. Therefore, he will not worry about the fiscal policy of the next administration until any new legislation is passed. But it seems likely that the political news could get the Fed to slow its program of rate cuts at some point, in anticipation of inflationary pressures from future tax cuts giving consumers greater spending power.
The Fed will still likely cut short-term rates at a measured pace into 2026, but will not return these rates to zero. Figure on the one-month Treasury bill’s yield falling to about 3.0%, and the bank prime rate ending up around 6.0%, down from its current 8.0%, after the Fed is finished reducing its benchmark rate.
Long-term rates are not likely to fall by much as short-term rates come down, because a faster-growing economy could stoke inflation fears among bond investors. As a result, long-term rates will once again be greater than short-term rates, a return to the traditional pattern after years of an inverted rate curve (economists’ term for when short-term rates are higher than long-term rates).
The Fed will continue to reduce its Treasury securities portfolio. Powell has emphasized that it is still the Fed’s goal to lower the overall amount of Treasuries and mortgage-backed securities it holds, in order to get its portfolio back to an historically more normal level. This gradual reduction in the Fed’s balance sheet could also push yields on longer-term Treasury bonds a bit higher, since the market will have to soak up more of Washington’s debt, and investors may demand a higher yield to do so.
Recent declines in mortgage rates stopped with the rise in long-term Treasury yields. 30-year mortgage rates will stay above 6.5% for now, and 15-year rates at around 6.0%. Mortgage rates are still higher than normal relative to Treasuries, but the eventual Fed cuts in short-term rates will boost banks’ lending margins, which should lower mortgage rates a bit next year.
Other short-term interest rates will come down at the same pace as the Federal Funds rate. For investors, rates on super-safe money market funds will be slipping below 5%, if they haven’t already. Rates on consumer loans will improve. Rates on home equity lines of credit are typically connected to the prime rate (now 7.5%), which in turn moves with the Federal Reserve’s benchmark rate. Vehicle financing rates are running about 7.0% for six-year loans to borrowers with good credit. These may not decline much, since they are also affected by what long-term bond yields do.
Top-rated corporate bond yields have also edged up in tandem with Treasury yields, but low-rated bond yields have continued on a downward path as recession fears fade almost completely. AAA-rated bonds are now yielding around 4.8%, BBB bonds 5.4%, and CCC-rated bond yields are around 11.6%.
