Topline
Federal Reserve officials discussed concerns about how the policies of President-elect Donald Trump will impact the central bank’s commitment to bring inflation back down to its 2% target — and investors have rapidly adjusted their expectations for interest rates in 2025, fearing higher rates for longer.
Federal Reserve Chairman Jerome Powell speaks at a 2024 press conference.
Key Facts
The minutes from the hawkish Dec. 18 meeting of the Fed’s policy-setting Federal Open Market Committee, which came out Wednesday afternoon, revealed the root of the pause from Fed staff: The looming shift in Washington.
“The effects of potential changes in trade and immigration policy suggested” restoring 2% inflation “could take longer than previously anticipated,” according to the minutes.
And “almost all” Fed officials “judged that upside risks to the inflation outlook had increased,” the release stated.
Given Trump’s “policy mix will likely be somewhat inflationary, the Fed also has less room to lower rates,” JPMorgan Chase’s chief U.S. economist Michael Feroli predicted in a note to clients previewing the minutes release.
Tangent
The Fed is already only anticipated to cut rates one more time in 2025, at least according to derivatives market data tracked by CME Group’s FedWatch Tool, which indicates a single 0.25 percentage point cut to a 4% to 4.25% target range is the most likely scenario by year’s end. That’s a far cry from the 2.5% or lower rates set from 2009 to 2021, between the Great Recession and the COVID-19 inspired inflation bout. It’s also a noticeable recalibration from the 3.5% to 3.75% range priced in a month ago, as expectations for looser monetary policy more friendly to borrowers and equity valuations alike were upended by renewed inflation worries. Also indicating evaporating rate cut optimism was turmoil in the heavily correlated bond market. Yields for 10-year U.S. Treasury notes rose to 4.7% on Wednesday, their highest level since April. That’s more than a full percentage point higher than rates were when the Fed started its rate cutting cycle in September, defying conventional wisdom that less tight monetary policy would likely lead to lower bond yields. Higher yields indicate less willingness from investors to hold government bonds, which are loans to finance government operations, signaling less faith in the financial health of the federal government.
Key Background
The Fed only officially determines the target federal funds rate, the range at which financial institutions can lend reserve cash to one another in overnight transactions, but the Fed interest rate decisions heavily influence borrowing costs across the economy. After hiking rates rapidly in 2022 and 2023 in response to the worst inflation the U.S. encountered in four decades, the Fed instituted its first rate cut in 4.5 years last September, lowering rates from 5.25%-5.5% to 4.75%-5%. Things did not exactly go as planned from there, as higher than expected monthly inflation readings, agita about lingering consumer price increases from tariffs and the unwieldy $36 trillion national debt threw a wrench in plans to return to neutral monetary policy.
Mortgage Rates Keep Rising
Surging yields are a challenge for borrowers, as the 10-year is used as a benchmark for many loans, including mortgages. In fact, the average 30-year mortgage rate rose last week to a six-month high of 6.99%, according to Mortgage Bankers Association data released Wednesday, up from the 6.1% average mortgage rate in mid September.
Crucial Quote
The probability of a stock market correction due to monetary and fiscal policy unrest is “much higher” than what’s currently priced in, Torsten Slok, the chief economist at asset management firm Apollo, told Bloomberg on Tuesday. “Higher for longer” interest rates have “a number of consequences that are bringing back memories of what we saw in 2022 when you had rates going up and stocks going down at the same time,” Slok continued. The S&P 500 fell 19% in 2022, the worst year since 2008. The stock market has yet to flash too red this time around, though the S&P is down more than 3% from its all-time high set last month, a slip at least partially attributable to policy worries.
Further Reading