Economists at Capital Economics predict a significant decline in the yield of the U.S. 10-year Treasury note, despite it currently hovering at a 16-year high. This projection comes as rising treasury yields create pressure on U.S. stocks, with investors anticipating a prolonged period of elevated interest rates.
The current yield on the 10-year Treasury (BX:TMUBMUSD10Y) slightly dropped to 4.257% on Friday from Thursday’s 3 p.m. level of 4.260%. In August, it reached its highest level since 2007, peaking at 4.339% (according to Dow Jones market data).
Market traders have factored in a greater than 90% probability that the Federal Reserve will maintain its benchmark interest rate during September. Additionally, there is a 42% chance of another interest rate hike by the end of the year. Moreover, they are estimating a 38% likelihood that the central bank will retain its policy rate within the current range of 5.25% to 5.5% until June of next year, as stated by CME’s FedWatch tool.
Disinflation and the U.S. Inflation Outlook
According to Diana Lovanel, a markets economist at Capital Economics, the persistence of disinflation in the United States does not necessarily require central banks to maintain elevated policy rates for an extended period. In a note issued on Friday, Lovanel expressed her belief that a prolonged period of sluggish economic growth is not necessary for inflation to reach the Federal Reserve’s target.
Lovanel expects disinflation to continue in the U.S., projecting that the inflation rate will edge closer to the Fed’s 2% target over the next twelve months. She highlighted the normalization of the labor market, which could bring wage pressure to a level consistent with achieving the desired inflation rate of 2%.
As Lovanel pointed out, another factor that may contribute to a decline in the inflation rate is the cooling rents in the country. These combined factors lead her to suggest that the Federal Reserve might undertake more substantial monetary policy loosening than what investors currently anticipate. Consequently, Lovanel expects Treasury yields to decrease throughout the remainder of this year and into next year.
Supporting this view, John Higgins, chief markets economist at Capital Economics, anticipates that the Federal Reserve will lower its policy rate by as much as 200 basis points in 2024. This projection is double the 100 basis points discount that investors are presently factoring into their calculations.
The Future of the Federal Funds Rate
Although the specific details regarding the expected increase remain unclear, it is evident that the advancement of artificial intelligence and other related factors will play a crucial role. These developments have the potential to elevate the equilibrium real interest rates, resulting in higher levels for the federal funds rate.
As we proceed into the future, it becomes increasingly apparent that artificial intelligence will significantly shape the economic landscape. This technological breakthrough has already showcased its impact in various industries and is poised to extend its influence further. Consequently, it is reasonable to expect a rise in equilibrium real interest rates, leading to an overall upward trajectory for the federal funds rate.
While the exact timing and extent of this shift are uncertain, it is essential to prepare for the evolving financial landscape. The implications of these alterations are bound to affect numerous sectors and require astute economic planning. Continued monitoring and analysis will be necessary to adapt and thrive in the face of these forthcoming changes.