Interest rates are headed lower - real yields suggest a half-point Fed cut is coming

By Mark Hulbert

The Iran cease-fire may be the 'green light' the Fed needs

U.S. Treasury real yields will influence the next interest-rate decision from Chair Jerome Powell and the Federal Reserve.

U.S. Treasury real yields - the difference between their nominal yields and inflation - are higher than at any time since the global financial crisis.

It's a good bet that interest rates will be lower in coming months - notwithstanding the ultimate resolution of the war in Iran, beyond the temporary cease-fire agreement, and the extraordinary volatility of energy prices to which the conflict has led.

That's because U.S. Treasury real yields - reflecting the difference between nominal yields and inflation - are higher than at any time since the 2008 global financial crisis, as you can see from the chart below. More often than not historically, above-average real rates have been followed in fairly short order by lower nominal rates.

To be sure, calculating real interest rates is not an exact science, since they are based on future inflation - and that is something we can only estimate. But most current estimates of future inflation fall within a narrow range, giving us at least some confidence that the real yields based on those estimates are well-founded.

You might object that estimates of future inflation are particularly speculative right now, given the still-unresolved war in the Middle East and the possibility that recent turmoil in the oil market could lead to significantly higher inflation.

While that is a valid objection, especially for calculations of the 1-year real yield, it seems unlikely that the war will have a significant impact on average inflation over the next decade. And as you can see from the chart, both the 10-year and 1-year real yields follow a similar pattern - and are above their respective two-decade averages.

Read: 15 stocks to put on your list to buy when the market recovers

R-star power

This conclusion is reinforced by economists' calculations of the so-called natural interest rate, otherwise known as r-star. That is the federal-funds rate considered to be neither stimulative nor restrictive - what would prevail if the economy were at full employment but not overheated, with inflation stable. Though r-star is not directly observable, many of the leading models calculate it to be lower than the current fed-funds rate.

One of best-known of those models is named for the three Federal Reserve economists who devised it: Kathryn Holston, Thomas Laubach and John Williams. The latest quarterly estimate from the HLW model, according to the New York Federal Reserve Bank, is that r-star stood at 0.92% at the end of 2025. That is below the current inflation-adjusted fed-funds rate, which is 1.3%. (I calculated this real fed-funds rate by taking the nominal current rate of 3.7% and subtracting the CPI's trailing 12-month rate of 2.4%. If I had used expected 12-month inflation as calculated by the Cleveland Federal Reserve, the current real fed-funds rate would be 1.4%.)

The bottom line: Short-term interest rates appear to be too restrictive to the tune of about half a percentage point. Don't be surprised, therefore, if the Fed cuts rates by that much as soon as the geopolitical dust settles.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: What the market is now pricing for Fed and global central bank interest rates after the cease-fire

Also read: Cease-fire means the bottom is in for the stock market, declares strategist Tom Lee

-Mark Hulbert

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04-11-26 1353ET