On Wednesday, December 18, 2024, the Federal Reserve delivered its final policy decision of the year, cutting interest rates by 25 basis points and providing a glimpse into its outlook for 2025. This move, while anticipated by many, came with some surprising projections that have significant implications for the financial markets and the broader economy.
The Rate Cut and 2025 Forecast
The Fed cut their policy rate by 25 basis points, reducing its overnight borrowing rate to a target range of 4.25%-4.50%, marking the third consecutive rate cut since September 2024. This brings the total reduction to 100 basis points over that period, signaling the Fed's responsiveness to changing economic conditions. However, the real story lies in the Fed's projections for 2025:
1. Fewer Rate Cuts: The Fed now anticipates only 50 basis points of rate cuts in 2025, half of what was projected in September.
2. Higher Inflation Expectations: The core PCE deflator, the Fed's preferred inflation measure, is now expected to end 2025 at 2.5%, up from the previous forecast of 2.2%.
Fed Chair Jerome Powell struck a cautious tone regarding future rate cuts. He emphasized that with the policy rate now significantly lower, the Fed can exercise more caution in contemplating further adjustments to the policy rate.
Market Impact
The Fed's more hawkish outlook for 2025 had immediate repercussions across financial markets:
US Stock Market: The S&P 500 index fell sharply following the announcement, with the Morningstar US Market Index losing more than 3%.
Global Markets: The cautious Fed outlook rippled through global markets, with many international indices following Wall Street's lead.
Bond Markets: Treasury yields surged in response to the Fed's projections. The 10-year Treasury yield jumped to 4.45%, returning to levels seen just after Trump's re-election.
Looking Ahead to 2025
The Fed's revised outlook suggests a more gradual approach to monetary policy easing in 2025:
1. Economic Resilience: The Fed raised its forecast for full-year GDP growth to 2.5%, half a percentage point above the September projection.
2. Inflation Concerns: The upward revision in inflation expectations indicates that the battle against price pressures is far from over.
3. Policy Uncertainty: The potential impact of President-elect Trump's policies, including tariffs and tax cuts, is factoring into the Fed's cautious stance.
As we move into 2025, investors and economists will be closely watching economic data and policy developments. The Fed's "higher for longer" approach to interest rates could have far-reaching implications for various sectors of the economy, from housing to business investments. While 2024 has been a banner year for U.S. equities, with the S&P 500 gaining over 20% for the second consecutive year, the road ahead may be more challenging.
References:
Caldwell, Preston. “US Fed Signals Fewer or No Rate Cuts in 2025.” Morningstar UK, Morningstar, Inc., 19 Dec. 2024, www.morningstar.co.uk/uk/news/258592/us-fed-signals-fewer-or-no-rate-cuts-in-2025.aspx.
Cox, Jeff. “Fed Cuts by a Quarter Point, Indicates Fewer Reductions Ahead.” CNBC, 18 Dec. 2024, www.cnbc.com/2024/12/18/fed-rate-decision-december-2024-.html.
Knightley, James. “Fed Confirms a Slower and Shallower Rate Cut Story for 2025.” ING Think, 18 Dec. 2024, think.ing.com/articles/fed-confirms-a-slower-and-shallower-rate-cut-story-for-2025/.
Mikolajczak, Chuck. “Stocks Decline after Fed Cuts Rates as Expected.” Reuters, 18 Dec. 2024, www.reuters.com/markets/us/futures-inch-higher-markets-await-fed-decision-2024-12-18/.
Morgan, J.P. “Will a Shutdown Tarnish a Banner Year for U.S. Markets? | J.P. Morgan.” Jpmorgan.com, J.P. Morgan, 2024, www.jpmorgan.com/insights/markets/top-market-takeaways/tmt-will-a-shutdown-tarnish-a-banner-year-for-US-markets.
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