Yahoo Finance

Key Takeaways

• Investors have scaled back their expectations for Fed funds rate cuts in 2025, and an increasing number believe the central bank won't cut rates at all this year.

• The Fed funds rate is currently elevated above its historical level, at a range of 4.25% to 4.5%, which keeps borrowing costs for all kinds of credit relatively high.
  

• Stubbornly high inflation could prevent Fed rate cuts, especially if policies implemented by the Trump administration push inflation upward, as many economists anticipate.
  

The economy has been running hotter than expected lately, raising the possibility that the Federal Reserve will hold interest rates higher for longer—and potentially won't cut in 2025 as policymakers had predicted.

In recent weeks, every fresh bit of economic data has thrown a tiny bit of cold water on hopes in financial markets that the Fed will cut its influential federal funds rate in 2025, as it has done at its last three meetings since September. As of Wednesday, financial markets were pricing in a 15% chance that the Fed won't cut interest rates in the coming year, up from 4% a month ago, according to the CME Group's FedWatch tool, which forecasts rate movements based on fed funds futures trading data.

The Fed had held its key interest rate at a two-decade high for the year leading up to September in an effort to quash inflation. Since then, the central bank's policy committee has cut the rate by an entire percentage point over the course of three meetings.

Fed officials have said the rate is still "restrictive " at its current range of 4.25 %—4.5 %. That means it pushes up interest rates for all kinds of loans, discourages borrowing and spending, slows the economy, and drags inflation down.

Inflation is down from the four-decade high it hit in 2022 and running just above the Fed's annual target of 2%. However, progress has stalled in recent months. And, recent economic data suggests it might be a long time before it comes down to pre-pandemic levels.

"Despite some moderation, inflation remains stubbornly above the Fed's target, driven by factors like shelter costs and auto insurance," James St. Aubin, chief investment officer at Ocean Park Asset Management, wrote in a commentary. "This persistent inflation could force the Fed to maintain a restrictive monetary policy for longer than anticipated, potentially impacting economic growth and market valuations."

Wild Cards Ahead

The Fed uses its benchmark interest rate as its main tool to accomplish its two goals of keeping inflation under control while avoiding disturbances in the job market. In recent months, inflation has stayed stubbornly above the Fed's goal, while the unemployment rate has stayed low despite employers pulling back on hiring.

This week, new government data showed employers were opening up more positions, with no sign of mass layoffs in sight. A separate report from the Institute of Supply Management on non-manufacturing businesses showed prices in the service sector rose in December, raising fresh concerns that inflation could reignite.

Both of those factors could pressure the Fed to hold off on further rate cuts.

However, the economy's trajectory can turn on a dime and some economists see warning signs in the labor market data suggesting hiring may not be as resilient as it appears. Trump's tariff policies are another major wild card: taxes on imports could push up inflation, slow the economy, or both, and the impact could depend on which of his promised tariffs the Trump administration implements and how.