Skip to main content


Will interest Rates Return to Pre-Great Financial Crisis Levels?—If Fed Skips Rate Cut in July Than Skeptical First Rate Cut will bein September—Current Monetary Policy Less Restrictive ThanFed Expected—Higher Neutral Rate Likely—Result HigherTerminal Funds Rate—Tempers Stock Valuations —StockPerformance Will Rely Even More on Earnings Growth

Date Posted: April 18, 2024

Core Service Inflation Key to Further Slowing of Overall Inflation

Core Services CPI ex-shelter drove the recent upturn in the Consumer Price Index for March. Using one month results can be misleading while one year results may prove outdated. Instead, using 6-month annualized tracking data pictured by Wolf Street Research shows Core Services CPI ex-shelter jumped over six percent. While the overall increase in the CPI raises concerns, instead, the Fed favors using the Personal Consumption Price Index (PCE) for measuring inflation, which so far this year tracked below the CPI. It should be noted that key components of the Core Services CPI index, such as motor services insurance and medical services, will not be included in the PCE Price Index. Additionally, shelter services play a lesser role in the PCE Price Index. As a result, PCE inflation may show a lower rate of inflation but still above the Fed’s two percent inflation target.

Figure 1

Sources: Bureau of Labor Statistics,
Will Interest Rates Return to pre-Great Financial Crisis Levels?

Economists reduced their forecasts from three rate cuts to one or two due to the recent reports of a strong economy and sticky inflation. At the same time, a minority of economists now predict no rate cuts at all this year. Many expect interest rates will remain higher-for-longer. Long-term interest rates may return to pre-Great Financial Crisis levels, ending the abnormal decade when Treasury bills averaged only 1.5 percent (see Figure 2.)
Figure 2
6-Month Treasury Bill Secondary Market Rate, Discount Basis

10 Year Market Yield of U.S. Treasury Securities on Constant Maturity Basis

Sources: Board of Governors of the Federal Reserve System,

If Fed Skips the First Rate Cut in July Than Skeptical the First Cut Will Be in September –Increased Early Voting—Heated Presidential Campaign Also Will Start Earlier—Result Likely Delays Rate Cut Past September

The concern that inflationary pressures will persist longer than initially anticipated once again leaves the Fed waiting longer to cut rates. The futures markets give a low probability for a funds rate increase in June, with the next meeting scheduled at the end of July. If the Fed skips a rate cut in July, it raises doubts there will be a first rate cut in September. Despite Fed officials stating that politics will not influence their decisions, the trend towards early voting will lead to a high intensity presidential campaign starting early in September if not sooner. Given that political backdrop, we remain skeptical that the Fed will make their first rate cut just six-seven weeks before the election.

Current Funds Rate less Restrictive than Fed Expected—Neutral Rate Likely Increased

The neutral rate of interest(R-Star) plays a key factor in determining monetary policy as it represents the interest rate at which inflation stabilizes at the target rate with full employment. However, it cannot directly be observed. Nonetheless, the Federal Reserve Bank of New York provides estimates that show a declining neutral rate since the 1960’s (see Figure 3.) Despite the current Fed funds rate of 5 ¼- 5 1/2%, the economy experienced better than expected growth and historically low unemployment rates. That raises the question whether the current funds rate produced the restrictive economic impact the Fed expected. For example, Minneapolis Federal Reserve President, Neel Kashkari, stated, “These data lead me to question how much downward pressure monetary policy is currently placing.” He then said, “It is possible, at least during the post-pandemic recovery period, that the policy stance that represents neutral increased.”

Figure 3
R-Star Neutral Rate of Interest

Source: Holston-Laubach-Williams model, Federal Reserve Bank of New York

Strength of the Economy and Financial Markets—Higher Neutral Rate—Higher Terminal Funds Rate

The observed strength of the economy and financial markets suggest the neutral rate may be increasing due to improvements in work force growth and potentially productivity gains. For example, the Congressional Budget Office recently revised upward its ten-year work force estimate by 7.4 million people or 2.6 percent, in its annual report. Additionally, The Hamilton Project at the Brookings Institution
found greater growth in the Establishment Survey of labor force and employment compared to the Household Survey used for measuring unemployment trends (see Figure 4.) The Study suggests unreported immigration likely contributed to this greater growth. Comparing projected monthly job growth before the pandemic with actual numbers, the study revealed an increase of roughly 100,000
jobs, indicating a healthy job market without overheating (see Figure 5.) Overall, these improving work force demographics will likely lead to both a higher neutral rate and terminal funds rate in the future.

Figure 4
Difference in Jobs Between the BLS Establishment Survey and the Household Survey–Immigration? (millions of jobs)

Source: Hamilton Project-Brookings Institution

Figure 5
Potential Employment Growth, Monthly—Adjusted for Higher Immigration—Approximately 100,000 Monthly Job Increase

Sources: Hamilton Project-Brookings Institution, Congressional Budget Office

Growing Investment in Generative AI—Increasing Demand for Capital Investment—Low National Saving—Need Foreign Capital—Increases Trade Deficit

Looking ahead to the rest of this decade, many economists forecast implementing generative AI will significantly boost economic productivity compared to the previous decade. This goal will likely necessitate increased capital investments potentially leading to higher interest rates. To finance these investments, a positive net national saving will be crucial. Despite positive net saving in both the business and personal sectors, federal deficits pulled down overall national saving to a low positive or even negative level, abnormal during periods of economic growth (See Figures 6 and 7.) This may result in the need to source capital from foreign sources, potentially widening the U.S. trade deficit.

Figure 6
U.S.Net National Saving

Sources: U.S. Bureau of Economic Analysis,

Figure 7
Net Government Saving

Sources: U.S. Bureau of Economic Analysis,

Investment Conclusions
Financial markets and the economy may face higher interest rates reminiscent of those before the Great Financial Crisis. This rate pressure will largely result from financing the rapidly growing federal deficit. If this prediction proves correct, price/earnings (PE) ratios will likely be tempered with stock performance more dependent on earnings growth. Surprisingly, companies with strong earnings growth from solid returns on free cash flow and equity, may even be more favored despite the higher rates. In contrast, unprofitable companies and those with weak balance sheets dependent on floating rate debt could struggle under a higher rate regime. In times of greater financial, economic, and geopolitical uncertainty, even greater focus on quality will be crucial for investors seeking underlying strength.

Fixed Income: The Fed seems less inclined to reduce the funds rate multiple times this year. Nonetheless, based on comments from Fed officials, they may still cut the funds rate at least once this year. If this scenario unfolds, investors in short- term fixed income investments will encounter increasing reinvestment risk. We previously noted that Treasury notes and bond rates offer attractive rates of return for the first time since the Great Financial Crisis and suggested extending duration. While this strategy still appears suitable, it should be implemented more gradually in line with the reduced rate cut expectations from the Fed.
Alternatives: Amidst changes in the financial industry and markets, alternatives offer diversification benefits by being less correlated with stocks and bonds. In this uncertain investment environment, alternative investments can both help manage risk and potentially enhance returns.