Interest rate forecasting

In a capitalist economy the most important cost is the cost of capital. The time value of money in the U.S. is partially determined by the markets and partially by the Federal Reserve.

Fed Chair Jerome Powell spoke in Amsterdam yesterday. The markets focus on the short-term fed funds rate but longer-term rates are also impacted and affect all asset markets.

Fed Chair Jerome Powell Maintains Wait-and-See Posture on Inflation and Rates

‘We’re just going to have to see where the inflation data fall out,’ says central bank leader

By Nick Timiraos, The Wall Street Journal, May 14, 2024

Federal Reserve Chair Jerome Powell affirmed the central bank’s plans to hold interest rates at the highest level in more than two decades as it awaits evidence that a slowdown in inflation will resume after setbacks this year.

Powell said he expected inflation to continue heading lower but that he was less confident than he had previously been about that outlook, leaving the Fed unable to say whether or when it might be able to lower interest rates. …

The Fed’s cautious stance toward rate cuts is increasingly pointing to divergence from other major central banks. Powell appeared alongside Dutch central-bank governor Klaas Knot on Tuesday, who signaled that the European Central Bank was prepared to begin lowering interest rates at its meeting next month. [end quote]

There are reasons to expect inflation to cool. But the economy is still strong and the labor market is still hot which supports higher inflation.

The fed funds rate is steady but the long term Treasury yields are in a rising trend. The yield curve is almost flat as longer term yields have risen almost as high as the fed funds rate. The Treasury yield curve no longer has a strong negative slope.

The 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity rate has been a consistent indication of coming recession since 1980. The yield curve flattens and then becomes positive before the start of the recession. But in previous recessions the curve flattened because the Fed cut the fed funds rate. Today, the curve is flattening because the longer duration yields are climbing even as the fed funds rate is staying the same.

If other central banks cut their short-term rates while the U.S. Federal Reserve maintains a high fed funds rate the USD will strengthen. That will make U.S. exports less competitive in foreign markets and ultimately depress the stock market.