The Federal Reserve’s recent interest rate outlook has surprised markets, leading to speculation and varied predictions for 2025. The central bank’s shift towards inflation control has ignited discussions about potential policy outcomes, with Wall Street anticipating a prolonged pause in rate cuts given robust economic growth and persistent inflation.
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Following the December Federal Open Market Committee (FOMC) meeting, investors swiftly recalibrated their interest rate expectations. While the Fed implemented a 25 basis point rate cut, their forward guidance signaled a more hawkish stance on future reductions. According to the CME FedWatch tool, markets now anticipate a 66% probability of one or two quarter-point cuts in 2025, aligning with the revised projections from policymakers. The FOMC’s summary of economic projections indicates a reduction in anticipated rate cuts from four to two in 2025.
Interestingly, market sentiment also reflects a growing belief that the Fed might maintain current interest rates throughout 2025. The likelihood of rates remaining unchanged by December 2025 has surged to 18.5%, a significant increase from 6.6% just a week prior. Furthermore, the probability of a Fed pause in January appears highly likely, with markets pricing in a 91% chance of unchanged rates at the conclusion of the next FOMC meeting on January 29.
Prolonged Pause Anticipated Following Potential January Skip
Experts at RBC Capital Markets suggest that if the Fed opts to skip a rate cut in January, a prolonged pause is likely to ensue. While the firm still anticipates a 25 basis-point cut in the subsequent month, strategists question whether the Fed will resume rate reductions after a January skip.
Ed Yardeni, president of Yardeni Research, highlights the recent strength of economic growth as a key factor diminishing the need for significant rate cuts in 2025. The upward revision of US economic growth for the third quarter, with GDP expanding by 3.1% annually, supports this view. Concurrently, inflationary pressures have rebounded, with consumer prices rising 2.7% in November, exceeding the previous month’s 2.6% annual pace. Wholesale price inflation has also exhibited an upward trend after experiencing a decline earlier in the year. Yardeni anticipates stronger economic growth than the Fed’s projections, suggesting a potential extended pause for the FOMC.
Potential for Rate Hikes in 2025 Raises Concerns
Despite the prevailing sentiment towards a pause or limited rate cuts, concerns linger about the possibility of rate hikes in 2025. Fed Chair Jerome Powell acknowledged that a rate increase in 2025 remains a possibility, although CME futures currently do not reflect this scenario. Nicholas Colas, co-founder of DataTrek Research, notes Powell’s unwavering stance on the potential for a rate hike.
Contrary to market expectations, some analysts believe the probability of a rate hike is higher than currently perceived. Torsten Sløk, chief economist at Apollo Global Management, estimates a 40% chance of a Fed rate hike in 2025. Sløk attributes this to the robust economy, coupled with the potential for lower taxes, increased tariffs, and immigration restrictions, increasing the likelihood of the Fed needing to raise rates. He draws parallels to 2022, characterized by high inflation, rising interest rates, and declining stock prices, cautioning investors about potential downside risks to traditional investment portfolios.
Inflation Remains a Key Determinant
The persistence of inflation poses a significant threat to forecasts for continued rate easing. Jamie Cox, managing partner at Harris Financial Group, emphasizes the Fed’s awareness of stubbornly high services inflation. This necessitates allowing the initial rate cuts to take effect, signaling the Fed’s willingness to halt or even reverse course if inflation does not subside.
Conclusion: Uncertainty Clouds the 2025 Interest Rate Outlook
The Fed’s unexpected rate outlook has created considerable uncertainty regarding the trajectory of interest rates in 2025. While market consensus leans towards a prolonged pause following potential rate cuts, the possibility of a rate hike remains a distinct possibility. The interplay between economic growth and inflation will be crucial in shaping the Fed’s future policy decisions, with persistent inflation potentially forcing a reassessment of the current easing cycle. Investors should closely monitor these factors and prepare for a range of potential outcomes in the coming year.
