While short-term interest rates have dropped this year as the Federal Reserve has begun cutting interest rates, long-term rates have risen amid economic resilience.
The three-month Treasury bill yield has dropped 67 basis points in 2024 to 4.73%. But the 10-year Treasury note yield has risen 31 basis points to 4.19%
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Short-term rates directly reflect the Fed’s rate policy. And it slashed the federal funds rate target by 50 basis points last month to 4.75%-5%. That rate applies to overnight interbank loans. Banks lend money to each other to keep their reserves stable.
Many experts anticipate the Fed will continue trimming rates. Interest-rate futures indicate an 89% chance of a 25-basis point cut at the central bank’s next meeting Nov. 6-7. The remaining 11% see no change, according to CME FedWatch.
Here’s the scuttle on long-term rates
Fed rate reductions tend to stimulate the economy and inflation. That’s why long-term rates are rising. Already, GDP has grown at an annualized rate of 3% in the second quarter. And the Atlanta Fed’s forecasting model calls for 3.4% in the third quarter.
Harvard economist Larry Summers is an expert who believes long-term rates stay high. “Markets should be getting used to rates in current ranges for the foreseeable future and probably long rates above current levels,” he said in a June 4 webinar cited by Bloomberg.
Related: Fed official's latest words reignite interest-rate cut debate
The 10-year Treasury yield stood at 4.33% that day.
Higher long-term rates are a good thing for investors who hold bonds until maturity, because they’re locking in a lofty rate.
If you’re looking for bonds with higher interest rates than Treasuries, you might consider investment-grade corporate bonds. Keep in mind that you’re sacrificing some safety for the higher yields. A 10-year single-A-minus JPMorgan Chase bond yields 5.06%.
T. Rowe Price's view on long-term interest rates
Arif Husain, head of fixed income at renowned fund manager T. Rowe Price ($1.63 trillion of assets), looks for long-term rates to rise soon.
“Market consensus expects the yield on the 10‐year U.S. Treasury note to decrease with the Fed kicking off a rate-cutting cycle,” he wrote in a commentary.
Related: Druckenmiller, Summers deliver blunt messages to Fed on interest rates
“But could a combination of factors— not least fiscal largesse in a U.S. election year — push the 10‐year Treasury yield up from its near 3.80% level in early October?” His answer is yes.
As for fiscal policy, the budget deficit totaled $1.8 trillion in the fiscal year (2024) ended Sept. 30.
“I think the 10‐year Treasury yield will test the 5.0% threshold in the next six months, steepening the yield curve,” Husain said. A steepening yield curve occurs when long-term yields rise more (or fall less) than short-term yields.
Why T. Rowe Price sees a 5% yield
He points to three factors behind his prediction.
1. “Fed rate cuts could limit yield increases on short‐maturity Treasury bills.
2. “Ongoing bond issuance by the Treasury to fund the government’s deficit spending is flooding the market with new supply.” A rising supply of bonds pushes bond prices down and yields up.
3. “The Fed’s quantitative tightening has taken a large, reliable buyer of Treasuries out of the market, further skewing the balance of supply and demand in favor of higher yields.”
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Quantitative tightening is when the Fed sells bonds in the open market, keeping its sales proceeds out of public circulation, thus shrinking the money supply.
Husain offered his most likely economic scenario: “midcycle adjustment,” as he called it.
“China injects more stimulus into its economy, providing a boost to global growth,” he said. “The cloud of uncertainty around the U.S. election clears up quickly, allowing the Fed to make its rate cuts relatively shallow.”
Related: Veteran fund manager sees world of pain coming for stocks
