Is the Federal Reserve’s plan to sustain higher interest rates a viable strategy? That’s the big question, especially if it risks damaging the U.S. economy. However, most media outlets reassure that everything is on track. They anticipate the Fed successfully curbing inflation to its target rate by 2024 without plunging us into a severe recession.

Though there’s a consensus that the Fed will eventually change its rate policy, there’s a split in views on why they might cut rates. The prevailing belief is that the Fed will likely reduce rates in 2024 after securing a smooth economic slowdown—a notable accomplishment considering the historic pace of interest rate hikes.

Yet, there’s an alternative view expressed by analysts at Morgan Stanley and UBS. They foresee rate cuts next year, not because the Fed orchestrated a soft landing to slow the economy and dodge a recession. Instead, according to UBS economists, the U.S. economy could face a full recession or a hard landing in the coming year, compelling the Fed to slash the overnight rate by 275 basis points throughout the year—almost quadruple what the stock market has factored in. Their forecast suggests the fed funds rate could plummet from 5.5% to 2.375% by the end of 2024.

The fact that the Fed has…

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held rates steady in three of its four recent policy meetings has led some economists to speculate that the central bank might be done with rate hikes. However, the Fed has cautioned that it retains the option to hike rates again if inflation picks up. Nonetheless, the FOMC’s projections indicate a gradual decline in the Fed Funds rate from the current 5.5% to 2.9% by 2026.

While the Fed Funds rate doesn’t directly influence Home Equity Conversion Mortgage rates, it offers insights into historical trends when compared to the 10-year Treasury. Observing the Federal Funds Effective Rate alongside the market yield of the U.S. 10-year Constant Maturity Treasury shows that U.S. treasury yields usually move sideways in the year leading up to the Fed’s first rate hike. However, once the Fed initiates its rate hike cycle, treasury yields historically rise considerably for the next two years.

Yet the relationship between the Fed Funds Rate and the 10-year Treasury yield has evolved. Former St. Louis Federal Reserve member Daniel Thornton argued in a 2008 paper that when the Fed started using the funds rate as a tool for monetary policy instead of an operating instrument, it caused a divergence between the fed funds rate and long-term treasury yields. This aligns with Goodhart’s Law, which suggests that when a measure becomes a target, it loses its effectiveness as a measure.

One could argue that the 10-year Treasury is a more accurate gauge of economic conditions and investor confidence. Investor confidence in the economy or government spending and debt directly impacts the premium or interest rate demanded by those purchasing long-term Treasuries.

All in all, even if the Fed pivots and reduces rates next year, the trajectory of 10-year treasuries may not follow a similar trajectory due to economic or inflationary pressures.

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