-
The Fed surprised markets with its interest rate outlook next year.
-
Investors are eyeing a number of scenarios for 2025.
-
Wall Street sees a prolonged Fed pause as likely, given strong growth and hotter inflation.
The Fed scrambled the market's outlook for interest rates next year at its meeting this week, and investors are eyeing a number of possible policy outcomes as the central bank shifts its focus back to keeping inflation in check.
Investors quickly adjusted their rate expectations for the coming year after the Fed's December policy meeting. The central bank cut interest rates another 25 basis points but issued more hawkish guidance on the trajectory of future cuts.
Markets are pricing in a 66% chance the Fed will issue one or two quarter-point cuts next year, according to the CME FedWatch tool, in-line with what central bankers projected Wednesday. In the central bank's summary of economic projections, officials dialed back rate cut expectations from four to two reductions in 2025.
But the market also thinks the odds that the Fed won't cut interest rates at all next year have spiked. The chance that interest rates remain at their current level by December 2025 had risen to 18.5% by Thursday morning, up from 6.6% a week ago.
A January Fed pause, meanwhile, looks overwhelmingly likely, with markets pricing in a 91% chance rates will be unchanged at the end of the next Fed meeting on January 29.
According to RBC Capital Markets, if the Fed skips another rate cut in January, the central bank will likely enter a prolonged pause.
"If the Fed does 'skip' January, we are not sure they actually get started again," strategists said in a note, though the firm is still calling for a 25 basis-point cut the following month.
Ed Yardeni, the president of Yardnei Research, pointed to strong economic growth in recent months, which he said negates the case for the Fed to cut interest rates significantly in 2025.
Economic growth in the US was revised upward for the third quarter on Thursday, with GDP rising 3.1% on an annual basis. Inflation, meanwhile, has reversed course and ticked higher in recent months, with consumer prices rising 2.7% in November, slightly hotter than the prior month's 2.6% yearly pace. Wholesale price inflation has also edged up again after falling earlier in the year.
"We think that economic growth will be much stronger than the Fed expects," Yardeni wrote. "If real GDP growth beats the Fed's expectations, as we expect, then the FOMC may be on pause for a while."