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Long-term borrowers, including home buyers and businesses looking for term debt, wonder why today’s interest rates are so high and when they will fall. A mix of reasons will likely keep rates from dropping sharply and prevent a return to the extremely low rates of 2021.

Long-term interest rates are different from short-term interest rates, such as the Federal Funds rate that the Fed controls. The outlook for long rates depends on several factors, the first of which—but not the only one—is the path of future short-term interest rates.

Let’s say I want a safe investment for the next six months. I can buy a six-month Treasury bill. Or I can buy a three-month T-bill, and then roll it over at maturity to another three-month T-bill. If the yield on the 6-month does not match the combined yield on a 3-month plus the expected future 3-month yield, then traders will buy or sell until the two come into alignment. This concept works—roughly—even when we stretch the investment out 10 years or longer. And when long-term rates are analyzed as equal to a set of short-term rates, the issue is not just how high the Fed will push rates, but how long they will keep rates high.

Long-term rates may also be influenced by global factors. Think of the worldwide supply of savings and the worldwide demand for credit. The supply of savings includes personal savings, business savings and government savings. Similarly, demand for credit comes from the world’s consumers, businesses and governments.

Long-term rates in Europe and some other advanced economies have increased as their central banks tightened monetary policy. Rates have not risen so much in Asian countries. Generally, in a rapidly growing economy the demand for credit grows faster than the supply of savings, pushing interest rates up. The weak growth in the world economy this year and next argues against further gains in long rates around the world.

Inflation expectations push a country’s interest rate up or down, depending on whether inflation is projected to rise or fall. The FocusEconomics survey of economists around the world shows forecasts for U.S. and the other major economies dropping a good bit in 2024 and a little more in 2025. So that does not explain our rising long-term interest rates.

The federal deficit might be a cause of higher long-term interest rates, but not the whole story. Most of U.S. treasury debt is fairly short term. Roughly one-third matures in less than one year, and two-thirds in less than five years. More importantly, U.S. debt is sold globally, with many international investors owning our treasury securities. So long as the risk of default is minimal, the effect of debt being sold should be spread around the world. (That’s not to welcome huge deficits. Someday the chickens will come home to roost, but I don’t see that happening soon.)

Of all the possible explanations for higher U.S. long-term interest rates, the most likely is expectations that the Federal Reserve will keep short-term interest rates higher than previously expected. Skepticism abounded early in the Fed’s tightening (including me). After we doubters were proved wrong by the Fed, many (but not me) thought the Fed would cave in at the first sign of weakness. In recent months, belief that the Fed would be slow to cut short-term rates became widespread, thus the higher long-term rates.

Those long-term rates are likely to drop when markets sense that the Fed is actually close to cutting the Fed Funds rates. That’s likely to come in the spring of 2024, but not in 2023. Long rates will edge down even before the Fed eases, then move down more. But it’s unlikely we will get to the extremely low interest rates of 2020-21.

Mortgage rates have another challenge in that borrowers can easily refinance when interest rates fall. That makes potential buyers of mortgage-backed securities demand a higher starting interest rate. Investors would like to lock in today’s relatively high interest rates, but mortgages don’t guarantee them those high interest rates for years to come. Treasury securities do. (And most corporate bonds also have call provisions that enable companies to refinance at some point in the future.) Mortgage rates will come down a bit as the 10-year Treasury drops, but not too sharply.

Although this interest rate outlook is bad news for borrowers, it’s good for savers. And credit availability—the ability to borrow even if interest rates are high—should be good for credit-worthy companies and individuals.

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