The Unexpected Disconnect Between Monetary Policy and Interest Rates

November 4, 2024

It’s a known notion that financial markets are forward-looking. However, their assumptions for the future don’t always play out as expected. Since May of this year, rates have consistently trended lower due to greater confidence the Federal Reserve would soon start cutting interest rates. In mid-September, policy members decided it was time to reduce the rate for overnight borrowing by 50 basis points (one-half of one percent). While many thought this would cause rates to continue their decline, the market had other ideas. After the Federal Open Market Committee (FOMC) meeting, shorter-term rates have gone down, but, weirdly enough, longer-term rates have actually increased. How can this be? Let’s break down how this is possible.

Monetary Policy and Interest Rates

A common misconception is the Federal Reserve’s monetary policy controls the entire yield curve. In reality, it directly affects short-term maturities while the long end of the yield curve is tied to future inflation and economic growth expectations. This difference explains how the Federal Reserve can cut rates, all while longer-term rates are increasing. A perfect example of this can be seen between Treasury bills and mortgage rates.

Since the beginning of September, the 1-month Treasury bill declined from 5.27% to around 4.64%, whereas the 10-year Treasury note increased from 3.91% to roughly 4.36%. The 30-year fixed-rate mortgage, which is tied to the 10-year Treasury rate, rose from 6.43% to 6.73% during the same period. The rise in long-term rates can be attributed to stronger-than-expected economic reports, including the employment and inflation reports for the month of September.

Navigating Larger Purchases

Opposite ends of the yield curve moving in different directions can make navigating large purchases requiring a loan difficult. Purchasing a house, buying a car, or starting a business are all scenarios where rate movements defying expectations have long-lasting impacts. At Security National Bank, we are here to help you navigate these financial decisions. If you have any questions or concerns about the direction of rates, please reach out to your financial advisor. Your financial success matters to us.