With the rate tightening cycle coming towards its conclusion, economists are starting to contemplate when rates are going to start falling again, likely later this year.

In a new report, TD Bank’s economists say that, “Currently, there is broad market consensus that the Fed is within 25-50 basis points from the end of this tightening cycle and past experience would argue that long yields are likely to head south as 2006 unfolds, especially considering that the central bank is usually back in easing mode within 4-6 months of the end of a tightening cycle.”

“If we are correct in predicting that the U.S. economy is poised for a cyclical slowdown by the second half of this year, the Fed will be right on cue in cutting the fed funds rate in October, and continuing in 25 basis point increments through the first quarter of 2007,” it predicts. “This would return the fed funds rate to 3.75% under a combined 100 basis points in cuts. Likewise, we believe, 10-year Treasury yields will not exceed 4.45% in the current quarter before dipping to a low of 3.85% by early 2007.”

TD says that the outlook for short-term rates in Canada is quite similar, but operating under a slight lag relative to the United States. “The Bank of Canada is also in the midst of a rate hiking cycle, but it will likely extend into the second quarter with the overnight rate topping out at 4%,” it predicts. “The communiqué following Tuesday’s policy meeting supported this view,” it adds.

“As the year rolls forward, the Bank of Canada will also return to cutting the overnight rate, with the economy shouldering the weight of slowing demand in its dominant export market,” it says. “However, the jump off point in Canadian yields is lower and the economic slowdown is expected to be more tempered than that south of the border. As such, we believe the overnight rate will only be cut a total of 50 basis points to 3.5% by early 2007.”