Since
July
2023,
the
US
Federal
Reserve
has
kept
the
federal-funds
rate
at
a
target
range
of
5.25%
to
5.50%,
far
above
typical
levels
over
the
past
decade.
But
we
expect
Fed
officials
to
deliver
hefty
cuts
over
the
next
two
to
three
years
and
bring
the
federal-funds
rate
to
1.75%
to
2.00%
by
year-end
2026.
In
our
latest Economic
Outlook,
we
detail
that
downward
trends
in
inflation
will
make
this
pivot
possible.
Slowing
gross
domestic
product
growth
(and
a
slight
rise
in
unemployment)
in
2024
will
further
increase
the
chances
of
the
Fed
cutting
sooner
rather
than
later.
We
expect inflation
in
2025
and
2026 to
come
in
below
the
Fed’s
2%
target
and unemployment to
remain
slightly
elevated
(above
4%)
until
2027,
which
should
induce
continued
cuts
until
the
federal-funds
rate
is
just
under
2%.
Our
long-run
expectation
for
the
10-year
Treasury
yield
is
2.75%,
significantly
below
the
current
yield
of
4.20%
as
of
July
2024.
Why
Did
the
Federal
Reserve
Hike
Up
Interest
Rates
in
2022
and
2023?
Since
2022,
the
Fed
has
been
engaged
in
an
all-out
struggle
against
high
inflation.
From
March
2022
to
July
2023,
the
Fed
increased
the
federal-funds
rate
by
5
percentage
points,
marking
the
largest
and
fastest
rate
hike
in
40
years.
The
Fed
has
also
engaged
in
“quantitative
tightening” –
selling
off
about
$1.7
trillion
(£1.3
trillion)
from
its
long-term
securities
portfolio
since
June
2022.
The
United
States
(as
many
other
countries)
experienced
a
decade
of
low
interest
rates
after
the
2008
global
financial
crisis
and
the
great
recession.
The
10-year
Treasury
yield
averaged
2.4%
from
2010
to
2019,
compared
with
4.2%
today.
The
federal-funds
rate
was
near
zero
much
of
the
time,
averaging
0.6%
from
2010
to
2019.
We
did
see
interest
rates
tick
up
in
the
prepandemic
years
but
only
slightly
(the
10-year
averaged
2.5%
from
2017
to
2019,
and
the
federal-funds
rate
averaged
1.7%).
How
the
Economy
Has
Responded
to
Higher
Interest
Rates
Now
with
interest
rates
reaching
levels
not
seen
since
the
mid-2000s,
many
are
wondering
whether
we’ve
shifted
to
a
new
regime
of
higher
interest
rates.
Higher
interest
rates
have
meant
higher
borrowing
costs
for
consumers
and
businesses.
• The
30-year
mortgage
rate
stands
at
about
6.9%
as
of
July
2024,
a
massive
jump
compared
with
the
3.0%
average
in
2021
and
far
above
the
4.2%
average
in
the
prepandemic
years
(2017
to
2019).
• Mortgage
rates
reached
a
high
of
7.8%
in
November
2023,
the
highest
in
over
20
years.
Higher
interest
rates
are
designed
to
slow
down
spending
in
interest-rate-sensitive
sectors
like
housing.
This
cools
off
the
broader
economy,
helping
achieve
the
Fed’s
goal
of
reducing
inflation.
Yet,
the
US
economy
proved more
resilient
to
the
impact
of
higher
rates than
expected
in
2023.
Widespread
fears
of
a
recession
did
not
play
out.
Housing
activity
fell
sharply,
but
much
of
the
rest
of
the
economy
has
been
unscathed.
The
impact
of
the
surge
in
the
federal-funds
rate
has
also
been
somewhat
cushioned
by
the
inversion
of
the
yield
curve,
where
short-term
bond
rates
(such
as
the
fed-funds
rate)
are
higher
than
long-term
bond
rates
(such
as
the
10-year
Treasury
yield).
Recall
that
the
fed-funds
rate
is
under
the
direct
control
of
the
Federal
Reserve,
allowing
the
Fed
to
control
short-term
risk-free
interest
rates.
Longer-run
interest
rates
are
influenced
by
the
Fed
but
only
indirectly.
Contrary
to
much
commentary
in
the
financial
press,
yield-curve
inversion
is
not
contractionary.
There
is
a
historical
correlation
between
yield-curve
inversions
and
recessions,
but
the
statistical
significance
is
weak
using
cross-country
evidence.
From
a
causal
perspective,
an
inverted
yield
curve
actually
stimulates
the
economy
compared
with
a
flat
yield
curve
(holding
short
rates
fixed)
because
it
means
lower
borrowing
rates
on
long-term
debt.
Because
the
yield
curve
has
inverted
so
much,
the
Fed
has
been
forced
to
hike
the
federal-funds
rate
more
than
it
would
have
otherwise
to
sufficiently
cool
off
the
economy.
Of
course,
even
while
the
Fed
failed
to
cool
down
the
demand
side
of
the
economy
in
2023
very
much,
inflation
ended
up
falling
anyway
because
of
supply-side
improvement,
which
is
unrelated
to
monetary
policy.
When
Will
the
Fed
Lower
Interest
Rates?
We
expect
the
Fed
to
start
cutting
rates
beginning
with
the
Federal
Open
Market
Committee’s
September
2024
meeting.
The
Fed
will
pivot
to
monetary
easing
as inflation
falls
back to
its
2%
target
and
the
need
to
shore
up
economic
growth
becomes
a
top
concern.
1.
Interest-rate
forecast. We
project
the
federal-funds
rate
target
range
to
fall
from
5.25%
to
5.50%
currently
to
4.75%-5.00%
at
the
end
of
2024,
3.00%-3.25%
at
the
end
of
2025,
and
1.75%-2.00%
by
the
end
of
2026,
after
which
the
Fed
will
be
done
cutting.
Likewise,
we
expect
the
10-year
Treasury
yield
to
move
down
to
an
average
of
2.75%
in
2027
from
its
current
yield
of
4.20%.
We
expect
the
30-year
mortgage
rate
to
fall
to
4.25%
in
2027
from
an
average
of
6.80%
in
2023.
2.
Inflation
forecast. It
looks
like
inflation
will
return
to
normal
without
a
recession.
We
expect
inflation
to
fall
from
3.7%
in
2023
to
2.4%
in
2024
and
an
average
rate
of
1.8%
over
2025-28,
dipping
slightly
below
the
Fed’s
2.0%
target.
The
continual
downtrend
in
inflation
will
be
owed
greatly
to
the
unwinding
of
price
spikes
as
supply
constraints
ease
and
as
the
pace
of
economic
growth
slows.
Inflation
reports
showing
falling
rates
over
the
past
year
have
defied
the
predictions
of
those
in
the
stagflation
camp,
who
thought
that
a
deep
economic
slump
would
be
needed
to
eradicate
entrenched
inflation.
Instead,
the
inflation-GDP
trade-off
has
been
very
kind.
Admittedly,
this
timing
of
rate
cuts
is
slightly
delayed
compared
with
our
previous
expectation
that
the
first
cut
would
happen
in
the
first
quarter
of
2024.
But
an
uptick
in
inflation
in
January
and
February,
along
with
a
lingering
hawkish
bias
by
the
Fed,
ruled
out
cuts
in
the
first
half
of
the
year.
Although
the
odds
depend
on
Fed
members’
own
subjective
assessment
of
whether
progress
on
inflation
is
sufficient
to
begin
cutting
rates,
we
think
the
inflation
data
will
progress
sufficiently
to
allow
cutting
before
the
end
of
2024,
which
is
why
we
expect
the
first
cut
in
September
2024.
As
long
as
the
Fed
is
allowed
to
shift
to
easing
in
2024,
GDP
should
avoid
a
large
downturn
and
start
to
accelerate
in
2025
and
2026.
Housing
is
the
most
interest-rate-sensitive
major
component
of
the
GDP,
and
we
expect
another
6%
drop
in
housing
starts
in
2024.
Higher
mortgage
rates
combined
with
the
earlier
surge
in
housing
prices
mean
that
home
affordability
is
at
its
worst
since
2007.
Lower
mortgages
will
be
needed
to
avert
a
deeper
and
prolonged
downturn
in
the
housing
market.
Why
Do
We
Disagree
with
Other
Investors
(and
the
Fed’s
Signals)
on
Interest-Rate
Forecasts?
The
nearly
unanimous
view
now
is
that
the
Fed
is
done
hiking
rates,
but
there’s
still
much
debate
about
when
and
how
much
it
will
cut.
We
diverge
from
the
market
by
expecting
significantly
more
cutting.
By
the
end
of
2026,
we
expect
a
fed-funds
rate
around
175
basis
points
below
the
market’s
projection.
Fed-Funds
Rate
(%)
Expectations
(Bottom
of
Target
Range)
We
believe
the
Fed
will
seek
to
lower
rates
from
currently
“restrictive”
levels
to
a
more
neutral
stance
once
victory
over
inflation
comes
into
sight.
Economic
weakness
in
mid-
and
late-2024
will
push
the
Fed
to
pick
up
the
pace.
In
2025,
inflation
will
still
be
below
target
and
unemployment
a
bit
elevated,
which
will
induce
further
cuts.
We
expect
inflation
to
come
down
quicker
than
consensus
does,
which
is
why
we
expect
the
Fed
to
eventually
cut
interest
rates
more
aggressively
than
it
currently
projects.
Likewise,
other
investors
now
appear
too
pessimistic
about
how
quickly
inflation
will
fall.
How
Will
Fed-Funds
Rate
Cuts
Affect
the
Economy?
We
expect
that
GDP
growth
will
accelerate
in
the
latter
half
of
2025
as
the
Fed
pivots
to
easing,
with
full-year
growth
numbers
peaking
in
2026
and
2027.
The
resolution
of supply
constraints should
facilitate
an
acceleration
in
growth
without
inflation
becoming
a
concern
again.
We
expect
a
cumulative
200
basis
points
more
real
GDP
growth
through
2028
than
the
consensus
does.
Consensus
remains
overly
pessimistic
on
the
recovery
in
the
labor
supply
and
has
generally
overreacted
to
near-term
headwinds,
in
our
view.
How
Does
Inflation
Affect
Interest-Rate
Projections?
We
expect
inflation
to
fall
to
normal
levels
after
peaking
at
6.5%
in
2022.
We
still
think
most
of
the
sources
of
high
inflation
since
the
start
of
the
pandemic
will
abate
(and
even
unwind
in
impact)
over
the
next
few
years.
This
includes
energy,
autos,
and
other
durables.
Still,
supply
chains
are
healing
as
demand
normalises
and
capacity
catches
up.
These
factors
drove
inflation
down
to
3.8%
in
2023,
and
we
expect
the
rate
to
fall
further
to
2.4%
in
2024,
with
an
average
of
1.9%
from
2024
to
2028.
We’re
more
optimistic
about
inflation
coming
down
than
consensus.
We
think
consensus
underrates
the
deflationary
impulse
likely
to
be
provided
by
industries
like
energy
and
durable
goods
in
coming
years,
as
pandemic-era
disruptions
fade.
Where
Will
Interest
Rates
Be
in
2025
and
Beyond?
In
the
short
run
from
2024
to
2026,
our
interest-rate
forecast
is
centered
on
the
Fed’s
mission
and
attempts
to
smooth
out
economic
cycles.
The
Fed
seeks
to
minimise
the
output
gap
(the
deviation
of
GDP
from
its
maximum
sustainable
level)
while
keeping
inflation
low
and
stable.
When
the
economy
is
overheated
(that
is,
the
output
gap
is
positive
and
inflation
is
high),
as
today,
then
the
Fed
seeks
to
hike
interest
rates
to
slow
growth.
But
our
long-term
interest-rate
projections
are
driven
more
by
secular
trends
than
by
the
Fed.
Instead,
interest
rates
are
determined
by
underlying
currents
in
the
economy,
like
aging
demographics,
slower
productivity
growth,
and
higher
economic
inequality.
These
forces
have
acted
to
push
down
interest
rates
in
the
United
States
and
other
major
economies
for
decades,
and
they
haven’t
gone
away.
Regardless
of
what
happens
in
the
next
few
years,
we
expect
interest
rates
to
ultimately
settle
back
down
at
the
low
levels
prevailing
before
the
pandemic.
The
low
interest-rate
regime
will
resume
once
the
dust
settles
from
the
pandemic’s
economic
volatility.
For
this
reason,
our
interest-rate
forecast
includes
the
expectation
that
these
rates
will
stay
lower
for
longer.
Even
if
we’re
wrong
in
our
near-term
view
that
the
Fed’s
war
against
inflation
will
be
a
short
one,
our
long-term
view
on
interest
rates
remains
valid.
This
article
was
compiled
by
Emelia
Fredlick
and
Yuyang
Zhang
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