Kiplinger Interest Rates Outlook: Likely Fed Rates Cut in September

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Federal Reserve Chair Jerome Powell for the first time indicated a possible starting point for cuts in short-term interest rates, saying at a news conference on July 31 that: “A reduction in the policy rate could be on the table as soon as the next meeting in September. […] We’re getting closer to the point at which it’ll be appropriate to reduce our policy rate, but we’re not quite at that point.” While not a promise, the fact that Powell mentioned a possible move at the next Fed policy meeting on Sept. 18 is a strong indicator that he is likely to do so. Usually, he would not encourage speculation about when the Fed might act, saying instead that they would simply follow the economic data and proceed accordingly. But the recent progress on inflation, and possible slowing in the manufacturing and construction sectors, appear likely to give Powell the justification he needs to cut in September.

These recent data, and market expectations of a rate cut, may allow Powell to avoid charges of political favoritism that he’s cutting to help the current administration ahead of the election in November. We believe that the Fed would normally want to avoid making its first move during the middle of a presidential campaign, but data and widespread expectations appear likely to force the central bank to act. If it does nothing, that could also be seen as a political move designed to help the Trump campaign, if the inflation data really do warrant a rate cut. If the Fed does not act on September 18, we believe it will do so at its policy meeting right after the November 5 election. At whichever meeting the Fed makes its first cut, we think it will cut a second time at its meeting on Dec. 18.

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Once the Fed does start cutting interest rates, it will likely continue doing so into 2026, but will not return short-term rates to zero. Figure on the one-month Treasury bill’s yield falling to about 3.5%, and the bank prime rate ending up around 6.5%, down from the current 8.5%, after the Fed is finished reducing its benchmark rate.

Long-term rates are likely to react to better inflation reports and any economic slowdown by continuing to ease. 10-year Treasury yields should stay around 4% for now. Bond market participants so far have not been bothered by the continuing inverted yield curve, the abnormal situation in which long-term rates remain below short rates. Eventually, we expect that the yield curve will revert to upward-sloping, with long-term rates above short-term rates, but the current inversion could continue for some time to come.

The Fed will continue reducing its Treasury securities portfolio, even after it starts cutting interest rates. Powell has emphasized that it is still the Fed’s goal to lower the overall amount of Treasuries and mortgage-backed securities it holds, in order to get its portfolio back to an historically more normal level.

Mortgage rates have declined a small amount, following long-term Treasuries, and are now 6.7% on average for 30-year fixed loans, and 6.0% for 15-year mortgages. Continued good inflation reports this year could result in a further decline of a few tenths of a point. Mortgage rates are higher than normal now, relative to Treasuries. The recent rise in short-term interest rates has crimped lenders’ profit margins on long-term loans. The eventual Fed cuts in short-term rates will boost banks’ lending margins, and should bring some extra reduction in mortgage rates, too.

Other short-term interest rates have risen along with the Federal Funds rate. For investors, rates on super-safe money market funds are still above 5%. Rates for consumer loans have ticked up, as well. Rates on home equity lines of credit are typically connected to the prime rate (now 8.5%), which in turn moves with the Federal Funds rate, which is determined by the Federal Reserve. Rates on short-term consumer loans such as auto notes have also been affected. Financing a vehicle now costs roughly 7.0% for a six-year loan for borrowers with good credit.

Corporate bond rates have also edged down, as they often move with changes in long-term Treasury rates. AAA-rated bonds are now yielding around 4.6%, BBB bonds 5.4%, and CCC-rated bond yields are around 13.4%.

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