The Federal Reserve prefers the PCE index over the CPI when analyzing the impact of inflation on the economy. (The CPI is the basis for calculating the interest rate for I-Bonds and TIPS.)
The Cleveland Fed expresses the “inflation nowcast” in several ways.
Their quarterly chart shows that PCE inflation fell in 4Q24 but CPI held steady. Both measures are above the 2% goal so the Fed doesn’t have a reason to cut the fed funds rate as long as employment stays strong.
The fed funds rate is an overnight rate with only a limited impact on the economy. Longer-term bond yields have more direct impact on mortgages and other lending (including business lending). Because lenders are seeing more sticky inflation as well as other potentially inflationary changes (such as higher tariffs) the yields of longer-term lending are rising even though the short-term rate is falling. The slope of the Treasury yield curve is now positive.
The Fed Cut Rates. Mortgage Costs Went Up.
Surging Treasury yields have pushed borrowing costs higher
By Sam Goldfarb, The Wall Street Journal, Dec. 20, 2024
…
Longer-term Treasury yields are set not just by investors’ calculations about where short-term rates will go over the next couple of years, but also by their broad assessment of the risks of holding on to bonds for an extended period.
Factors such as stubborn inflation, elevated budget deficits, and the prospect of tariffs and tax cuts in a second Trump administration have all helped turn investors against longer-term Treasurys in recent weeks. As a result, the 10-year yield has climbed more than the two-year yield… [end quote]
The 30-year fixed mortgage rate hasn’t dropped along with the fed funds rate so the gap between them is growing.
The Macro economy depends on the longer-term rates. Very large government deficits at the same time as higher Treasury yields are driving ever-larger deficits.
The asset markets have become addicted to ultra-low interest rates. Even if the Fed cuts the fed funds rate quickly (which they won’t barring a crisis) the longer-term yields won’t fall as long as inflation is stubborn and demand for borrowing pressures the supply of money to be loaned.
Wendy