Do we have clarity on the future of interest rates?

The following blog post is an excerpt of a presentation shared during our recent webinar, ‘The Big Picture: Charting the Course for Capital Markets in 2025’. Access the on-demand replay of the webinar and download our Big Picture outlook report for further insights on interest rates, the IPO market, dividends, and other key factors shaping the capital markets in 2025. 

In mid-December, the Federal Reserve cut its benchmark interest rate by 25 basis points to a target range of 4.25%-4.5%. That's down 100 basis points since the Central Bank started cutting rates in September. After the Fed hiked rates at one of the most aggressive paces in its history to combat the worst inflation since the 1980s, 2025 was once seen as this year where we're going to see easing monetary policy and lots of rate cuts.

But as we've seen so far, inflation is proving far stickier than anticipated. Fed officials now expect only two 25-basis point cuts this year, about half of what they previously expected. It's a lot less than what the market was expecting, too. There's a sizable chunk of traders [in the futures market] who believe there might be only one cut this year, and some feel there might not be any cuts at all.

Core personal consumption expenditures, which is an inflation measure that excludes food and energy prices, was up 2.8% in its last reading. The Fed wants that number at 2% but it's been moving towards 3% over the past three months. If inflation continues to move in this direction, the likelihood of further rate cuts really dims.

New Jobs Report

The US unemployment rate dipped to 4.1% in December, still relatively low but higher than the levels seen right before the pandemic. [Editor’s note: this figure has been added to the blog post on Jan. 13, 2025 to reflect the jobs report released on Jan. 10, 2025. The report was published after this webinar and Brian’s comments.] If the unemployment number rises and the labor market shows serious signs of weakening, most expect the Fed will respond with lower rates. However, there are still a lot of unknown factors. First, how far is President-elect Trump really going to go with his tariff plan? We're seeing some conflicting headlines on that. How much will that cause inflation to rise? Could the Fed hike rates again this year if we see inflation spike?

If inflation rises and joblessness rises, too, what's going to concern the Fed more? Looking at it broadly, almost no one expects the Fed to return to near-zero rates, barring another pandemic or economic calamity, but the Fed looks to be setting expectations for longer-run rates that are higher than what many were forecasting just a few months ago. Take the neutral rate of interest, which is an interest rate level where monetary policy is in a state of equilibrium (rates are neither contracting the economy nor expanding the economy). Fed officials now see this neutral rate at 3%, about 50 basis points higher than their forecast a year ago and the highest level since 2018.

There's no real timeline for the Fed's return to neutral. Chairman Powell said in December that it could be a couple of years before that 2% inflation goal is reached. At the same time, there's a chance that the Fed could be out of step with the rest of the world's central banks.

Rates Abroad & Looking Forward

The European Central Bank (ECB) appears to want to return to neutral as quickly as possible, cutting its deposit rate 4x in 2024, ending the year at 3%. Expectations are that the ECB could even cut [the deposit rate] below 2% this year to keep the eurozone economy from falling behind its global peers.

The Bank of England appears to be taking cuts more gradually. The Bank of Japan, which ended its negative interest rate policy in March and caused a lot of market volatility when it raised its target rate to 0.25% in July, could be looking to further raise its target rate in 2025. It's a true reversal. For now, there's a real lack of certainty about where we're headed.