We are likely entering an interest rate cutting cycle, with markets pricing in two cuts for 2025 and more expected in 2026 (as of October 2025). Unlike most previous cutting cycles, this one is unfolding while the economy is strong, inflation remains stubbornly above the Federal Reserve’s 2% target and financial markets have reached record highs. The most notable concern is a softening labor market, which seems to be driving the Fed’s caution and the expectation of rate cuts.
Interest rates and the yield curve
The treasury yield curve shows how much interest the government pays to borrow money for different lengths of time. A “normal” yield curve means short-term interest rates are lower than long-term ones. This is a good sign and shows optimism for economic growth. Banks are more likely to lend money, because they can borrow money cheaply and earn more when they lend it out for longer periods. More lending means more spending, which helps businesses and creates jobs.
Typically, when short-term rates go down, longer-term rates also follow, making it cheaper for people and businesses to take out loans. Families can more easily buy homes or cars, and companies might invest in new equipment or hire more workers.
However, when the federal deficit is high, the government borrows more, which increases the supply of bonds and can keep long-term interest rates higher, creating a steeper yield curve.
Potential implications
When long-term rates are high, investors typically get paid more to lend money for a longer period of time, making long-term bonds more attractive—particularly in a strong economy. Investment vehicles that are priced to short-term rates, like money market funds or short-term bond funds, can become less attractive because their yields drop with rate cuts.
Fixed mortgage rates follow longer-term rates, so when the yield curve steepens, mortgage rates often stay higher. Housing affordability likely will continue to be a challenge for many families.
Keeping a close eye on rates
The current rate-cutting cycle is unusual due to the strength of the economy. While lower rates can stimulate borrowing and investment, a high deficit may keep long-term rates elevated. We continue to monitor these dynamics, as they will shape the markets in the months ahead.
David Royal is executive vice president and chief financial & investment officer at Thrivent.
