The Federal Reserve’s first policy meeting of 2025 is set for January 28-29, with market expectations that it will maintain the current interest rate levels after a series of cuts since September 2024.
The Fed’s dual mandate is to maintain price stability, aiming for an inflation rate of around 2% annually as measured by the Consumer Price Index (CPI), and to ensure full employment, though it does not set a formal target for the unemployment rate.
After successfully bringing down inflation from the highs of 2022, the Fed began cutting the federal funds rate in late 2024. However, concerns about persistent inflation remain, particularly as the CPI may stay above the 2% target for longer than anticipated. Consequently, the Fed has adjusted its 2025 interest rate cut projections.
Inflation’s Downward Trend Faces Challenges
The COVID-19 pandemic triggered significant economic disruption, prompting the U.S. government to inject trillions of dollars into the economy and the Fed to reduce interest rates to near zero, a move aimed at preventing a deep recession. The flood of money into the system, coupled with global supply chain issues caused by factory closures, resulted in soaring consumer goods prices. Inflation surged to a 40-year high of 8% in 2022.
In response, the Fed implemented one of the most aggressive rate hikes in history, raising the federal funds rate from 0.1% to 5.33% between March 2022 and August 2023. The measures proved effective, as the CPI dropped to 4.1% in 2023 and continued to decline into 2024.
However, after reaching an annualized rate of 2.4% in September 2024, inflation has recently picked up, rising for three consecutive months and reaching 2.9% in December.
A Pause in the Fed’s Rate Cuts Expected
The Fed typically releases its Summary of Economic Projections (SEP) four times a year—March, June, September, and December. The SEP outlines expectations for economic growth, inflation, and the federal funds rate. The most recent SEP revealed a reduction in the projected number of interest rate cuts for 2025, down from five cuts in September to just two in December.
This shift stems from upgraded expectations for economic growth, with the 2025 GDP forecast rising from 1.8% to 2.2%, and inflation projections for personal consumption expenditures (PCE) increasing from 2.1% to 2.5%. The Fed now anticipates a stronger economy in 2025, accompanied by higher inflation, leading to fewer rate cuts.
Traders on Wall Street, as per the CME Group’s FedWatch tool, expect only one rate cut in 2025, likely in June. This implies that the Fed may maintain its current stance for the next five months.
Lower Rates Could Boost Stocks, but Volatility Remains a Concern
While lower interest rates tend to support stock market growth, the Fed faces a delicate balancing act. Historically, the central bank has been criticized for keeping rates high for too long, often leading to an economic slowdown or even recession. The market will be closely monitoring the Fed’s actions in 2025 to gauge the long-term impact on both inflation and economic growth.
Conclusion
As the Fed adjusts its approach to managing inflation and economic growth, the pace and timing of future rate cuts will play a significant role in shaping market sentiment in 2025. While lower rates typically benefit the stock market, investors should remain cautious of potential volatility as the Fed navigates a challenging economic landscape. The coming months will be crucial in determining whether the Fed can balance its dual mandate effectively without triggering a slowdown or economic instability.