MADISON, Wis.–Credit union leaders and their ALCOs will likely need to wait until the spring before they see any reductions in rates by the Federal Reserve, according to the latest forecast from TruStage.
Writing in the company’s latest Trends Report, TruStage Chief Economist Steve In the short term, Rick pointed to the Fed’s December 2023 announcement that it will maintain the Fed Funds effective interest rate in the target range of 5.25%-5.50%, as well as its announcement it will also continue to reduce its holdings of Treasury securities, agency debt and mortgage-backed securities to keep upward pressure on longer-term real and nominal interest rates.
“We expect the Federal Reserve to keep the effective Fed Funds interest rate at the current 5.33% through the spring and then begin lowering it some-time this summer,” said Rick. “The Federal Reserve will lower the nominal Fed Funds interest rate to keep the real Fed Funds interest rate from rising as the inflation rate continues to fall. Recall the real interest rate = nominal interest rate – inflation rate.”
Rick pointed to the most recent core PCE deflator, which excludes food and energy prices and is the Federal Reserve’s preferred inflation gauge, which rose only 0.1% in November and 3.2% during 2023, as encouraging signs.
A History Lesson
“Moreover, looking at the annualized three-month moving average, the core PCE deflator came in at only 2.2% in November, barely above the Fed’s 2% official target,” Rick wrote. “Using this 2.2% inflation figure the real Fed Funds interest rate would be 3.11% (5.33%-2.2%). Historical data shows that when the real Fed Funds interest rate climbs above 3.5%, the likelihood of a recession increases dramatically. So, to ensure a ‘soft landing’ for the economy, the Fed will have to start lowering the nominal Fed Funds interest rate soon.”
The Forecast
Rick forecast the Fed will keep lowering the Fed Funds rate through 2024-2026 until it reaches the long–run “neutral” rate of 2.5%.
“This neutral rate is considered by the Fed as not too high to slow the economy and not too low to accelerate the economy,” he said. “Bond investors are expecting these lower short-term interest rates in the future, which is one reason why longer-term Treasury yields have declined by more than one percentage point since its high-water mark set back on Oct. 20.”
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