Expectations Tilt Toward Higher for Longer

By Bolton April 12th, 2024

By Zack Fritz, Sage Policy Group

The Federal Open Market Committee (FOMC), the committee within the Federal Reserve that sets the federal funds rate, released new economic projections during the third week of March. While the FOMC still expects three 25 basis point rate cuts through the remainder of 2024, they did alter some aspects of their forecast.

In the short term, the FOMC now expects that inflation will be slightly hotter, unemployment slightly lower, and GDP growth slightly faster than they had expected in December. This is consistent with recent economic data. Inflation, for instance, has reaccelerated during the first two months of 2024. While the year-over-year rate of price increases continues to drift lower, these hotter-than-expected data points suggest the fight to bring inflation back to the 2% target may take longer than expected.

At the same time, the labor market has continued to outperform expectations; employers are adding jobs at a rapid clip while jobless claims remain extraordinarily low by historical standards.

Looking at the longer term projections, the FOMC raised their forecast for interest rates in 2025, 2026, and over the “longer run.” Put simply, recent inflation data has the Fed thinking that interest rates will be higher for longer.

This general sentiment—that borrowing costs will not decline as quickly as expected—has altered other forecasts as well. Fannie Mae now expects the average 30-year fixed mortgage rate to end 2024 at 6.4%. That’s a half percentage point higher than their previous year-end forecast for 2024. Looking longer term, Fannie Mae expects that the average 30-year fixed rate mortgage won’t sink below 6.0% through the end of 2025.

The chilling effect of higher borrowing costs on homebuying activity will likely diminish over time as the lock in effect of low fixed rate mortgages secured during the early part of the pandemic fades. Many would-be homebuyers will abandon their wait-and-see attitude if rates truly stay higher for longer.

That’s not to say higher-for-longer rates won’t impact the economy. The FOMC now expects that the effective federal funds rate will average 2.6% over the longer run. That’s higher than at any point between 2009 and the fourth quarter of 2022.

This is unequivocally bad for some interest-rate sensitive segments. Certain privately financed construction segments, like office and retail, will struggle with high borrowing costs and tight lending standards. This effect will be exacerbated by the fact that manufacturing- and infrastructure-related construction activity will remain extraordinarily elevated due to federal incentives and funding, respectively, driving up the cost of both labor and materials.

Yet markets appear relatively unconcerned by the notion of higher for longer. Following February’s hotter-than-expected Consumer Price Index data, major indices actually rallied.

There’s precedent for strong market performance in a higher interest rate environment—just look at the 1990s—and it would only take a few months of cooler-than-expected inflation data, or a sudden uptick in unemployment, to accelerate rate cuts.

Ultimately, economic forecasters have struggled over the past few years, and it’s entirely possible that this current moment of higher for longer expectations proves as transitory as 2022’s burst of inflation wasn’t.