Fed rate cut, as we look ahead to 2025, the Federal Reserve's stance on interest rates remains a topic of intense discussion among economists and investors.
Despite ongoing speculation about potential rate cuts in 2025, the market may be misjudging the situation. Although inflation has decreased from its pandemic-induced highs, it remains elevated and shows no signs of significant decline. Even if upcoming data for January and February falls short of projections, the overall inflation trend appears flat rather than downward, contradicting the notion of lower interest rates.
Several key indicators suggest that higher interest rates may be more likely than cuts. These include:
Labor Market Resilience
Consumer Spending Trends
Rising Oil Prices
GDP Expectations
10-Year Treasury Yields
Each of these elements contributes to the case for maintaining or increasing interest rates.
The Federal Reserve operates under a dual mandate: to support economic growth while maintaining a stable labor market and controlling inflation. Current inflation trends indicate a lack of cooperation with this mandate. Although the labor market has cooled since its peak in 2022-2023, it remains robust. Job gains averaged 191,000 in 2024, with an unemployment rate around 4% and wage increases of 4%. Job availability is still strong, and jobless claims are at historically low levels.
However, there are some warning signs, such as data from Challenger, Gray, & Christmas, which highlight layoffs and hiring outlooks. Yet, even these numbers suggest volatility rather than a deteriorating labor environment.
Consumer spending in 2024 is projected to increase by over 3% compared to the previous year, outpacing core consumer inflation. This growth is expected to continue, with retail sales forecasted to rise to 3.5% or more in 2025. This uptick could exert upward pressure on prices, especially as certain economic policies take effect.
Oil prices play a significant role in driving inflation. After hitting a long-term low in Q4 2024, oil prices have rebounded strongly. Currently trading around $78.25, WTI oil is positioned within a multiyear trading range, suggesting the potential for further increases. If oil prices continue to rise, they will likely contribute to inflationary pressures in Q1 and throughout 2025.
According to the CME FedWatch Tool, which gauges Fed rate cut probabilities based on futures contracts, the likelihood of rate cuts in 2025 is diminishing. While there was previously some expectation for cuts, the probability of a reduction before July is now low. With only a 75% chance of a cut by year-end, market sentiment may shift, potentially leading to a stock market correction. However, any correction is unlikely to result in a sustained downturn due to the underlying strength of the economy.
The 10-year Treasury yield has been rising, reflecting the Fed's evolving outlook. Recently, it reached an 18-month high, supported by both short-term and long-term moving averages. As the yield continues to climb, it is likely to remain elevated, especially given the current spread relative to the expected FOMC base rate. The yield could rise an additional 40 basis points or more before stabilizing, making a Fed cut to 4% seem increasingly doubtful.
In summary, the combination of persistent inflation, a resilient labor market, strong consumer spending, and rising oil prices suggests that the Fed is unlikely to cut rates in 2025. As the central bank navigates these complexities, maintaining a cautious approach will be crucial. The economic indicators point to a landscape that favors higher interest rates, challenging the market's current expectations.
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