Investors are facing an unexpected new reality: The sooner the Federal Reserve feels it can stop raising interest rates, the less likely that it will need to cut rates in the future.
The end of the Fed's tightening campaign now seems in sight, if it hasn't already arrived. The central bank's policy makers on Wednesday left their target on overnight rates steady at a range of 5% to 5.25% -- the first time they didn't raise rates at the conclusion of a policy-setting meeting since January last year. They did indicate that they expect to raise rates by another half percentage point by the end of the year, more than many expected. But if the next inflation report shows signs of further cooling, even that could be in doubt.
Yet Fed officials don't think they will soon be bringing rates much lower than they are now, either, with their projections now showing they expect the rate range will be 4.5% to 4.75% at the end of next year. And investors are starting to recognize that this higher-for-longer expectation might come true.
When the Fed has raised rates in the past, it has often hiked them to the point where the job market cracks, plunging the economy into a recession that leads the central bank to quickly reverse course and cut rates sharply. Investors had been figuring that would be the pattern this time around: At one point in March, shortly after Silicon Valley Bank and Signature Bank collapsed, interest-rate futures implied an expectation that the central bank would lower its rate target to a range of 3.75% to 4%, or lower, by the end of this year, a contrast to current expectations that are roughly split between the Fed holding rates steady and raising them by a quarter point.
But although the job market has loosened a bit, it still looks quite healthy, with unemployment low and plenty of job vacancies waiting to be filled. As long as that is true, even if inflation cooled substantially, policy makers wouldn't see much point in cutting. Now interest-rate futures imply that the Fed's target range will finish out the year around where it is now.
This shift in expectations is having an effect on long-term interest rates, too. The yield on the 10-year Treasury, which in theory largely reflects investors' short-term rate expectations over the next decade, has lately been pushing higher faster than the yield on the 3-month Treasury. If inflation does, in fact, keep cooling, and the job market remains in good shape, then that is a trend that will continue, and might even lead to a point where long-term yields are higher than short-term ones -- not, as is usually the case when the yield curve un-inverts, because a recession has hit, but because one has been avoided.
This would, of course, be great news for the economy. But for investors, being stuck in a higher-for-longer rate regime would be a bit more complicated.
