If you’ve been searching to buy a new home, car, or staring at your credit card balance wondering why it’s growing faster than you’re paying it off, the likely culprit is sky-high interest rates.
The Federal Reserve has engaged in a tooth-and-nail battle with inflation since 2022. The good news is that they may be winning the fight. The bad news is that despite a recent shift to rate cuts to prevent the economy from stalling, rates haven’t budged much.
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The stakes are high for cash-strapped consumers, making what happens to interest rates next critical.
The Federal Reserve finds itself trapped by dual mandate
The Federal Reserve Bank is the Central Bank in the United States, and it was designed by an act of Congress in 1913. The Central Bank’s main responsibility, when created, was to enhance the stability of the American banking system.
More recently, the Federal Reserve Act of 1977 adjusted the Federal Reserve Bank’s mission.
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During the 1970s, the economy suffered from two major problems: high inflation and weak economic growth.
This stagflation led Congress to explicitly restate the Fed's goals to a combination of "maximum employment, stable prices, and moderate long-term interest rates."
The Fed’s aim for full employment and price stability is commonly known as its dual mandate. Depending on the economy's state, the Fed may sometimes focus on one goal over the other.
We’ve seen that play out over the past four years.
In the post-Covid period, inflation soared in 2021 and 2022, reaching levels not seen in decades. As a result, the central bank increased short-term rates to 5.50% in 2023. It left rates there for over a year to gain confidence that inflation had truly been tamed.
Following a significant decline in inflation this past September, the FOMC started a new rate-cutting cycle when it reduced short-term rates by fifty basis points or one-half of one percent.
This was an unusual move, as rate-cutting cycles do not typically start with a one-half-point rate cut unless the economy is dealing with a major financial crisis.
According to Ned Davis Research, “There has only been one non-recessionary easing cycle since 1970 that started with 50 bp—1984.”
Fed officials explained that the half-point (as opposed to quarter-point) rate cut was necessary because the Federal Reserve Bank had largely achieved the inflation part of its dual mandate. It was now turning its attention to addressing a weakening job market and doing its best to support the economy and pull off a “soft landing.”
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The Federal Reserve Bank followed up its initial one-half-point rate cut with a further one-quarter-point rate cut in early November 2024. So, the Fed Funds rate, which peaked at 5.50%, now stands at 4.75%.
The big move should’ve caused interest rates and loans tied to them, such as mortgage rates, to slide. Instead, they climbed to their highest level since summer, raising questions about whether the Fed is caught between a rock and a hard place regarding interest rate policy.
What’s next for interest rates in 2025
As we look to flip the calendar on December 31, there are some big unanswered questions about what to expect from the Federal Reserve Bank next year, including:
- What will be the Federal Reserve Bank’s ultimate target rate,
- How many rate cuts should investors expect in 2024,
- How frequently will the Central Bank reduce rates next year, and importantly,
- What factors are most likely to influence Fed policy in the year ahead?
Based on the CME’s FedWatch tool, which shows what traders think about the outlook for short-term interest rates, there is currently an 86% chance of a quarter-point rate cut (from 4.75% to 4.50%) at the next Federal Reserve Bank meeting on December 18th.
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The tool also suggests that there’s a 30% chance (the highest probability of all outcomes) that the Federal Reserve Bank will cut rates twice more to 4.00% by the end of 2025.
That may sound good, but investors were anticipating four rate cuts in 2025, not that long ago.
What the Fed is saying about interest rates in 2025
At every other meeting, Federal Reserve Bank officials come out with what is called a Summary of Economic Projections (known as the SEP report within financial markets), commonly called the dot-plot.
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The most recent September report highlighted that Federal Reserve officials currently forecast that short-term rates will end this year in a range of 4.40% to 4.60% and end next year in a range of 3.10% to 3.60%.
At his last press conference, Fed Chairman Jerome Powell stated that Fed policy is “not on a pre-set course,” suggesting to investors that the timing and number of future rate cuts will be somewhat uncertain in the year ahead.
If the decline in inflation continues and inflation moves towards the Fed’s 2% target level (or if economic growth slows notably), we will likely see more rate cuts in 2025.
However, if inflation remains sticky, starts to trend higher again, or if the economy picks up further steam, we could very well see fewer rate cuts in 2025.
Analysts' interest rate outlook for 2025
In its 2025 Global Market Forecast, published on December 3rd, 2024, J.P. Morgan Securities forecast 100 basis points of additional rate cuts (four one-quarter-point rate cuts) over the next year, with short-term rates moving down to a target level of 3.50%—3.75% by the third quarter of 2025.
Related: CPI inflation report sparks Fed interest rate cut bets
In an interview with a major news channel following the recent jobs report, Blackrock’s Rick Rieder (Global CIO of Fixed Income) commented that he expects a quarter-point rate cut next week, and then after that, it’s wait and see.
Goldman Sachs recently commented, “We continue to forecast consecutive cuts in December, January, and March, followed by quarterly cuts in June and September, but we now see a greater risk that the FOMC could slow the pace sooner, possibly as soon as the December or January meetings.”
An old saying in financial markets is, “Don’t fight the Fed.”
The good news for financial markets is that we are clearly in a new rate-cutting cycle that started this past September.
However, uncertainty about inflation, economic growth, tariffs, and immigration under Trump 2.0 could all contribute to greater uncertainty about the number of rate cuts we receive and the timing of these interest rate cuts in the year ahead.
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