Last week, the Federal Reserve reduced interest rates by 0.25 percentage points, marking the third consecutive rate cut. The move was largely expected, but what I find interesting are the revised forecasts from the Fed for the U.S. economy for 2025.
The Fed expects stronger GDP growth now revised up to 2.1% for next year, which is slightly above trend growth for the U.S. They also expect slightly lower unemployment with a rate hovering around 4%. But the linchpin in my opinion is that the Fed now forecasts inflation to be higher than its previous estimates. For the average American like you and me, this is not good news, but I can tell you it is in line with all the economic data I am seeing.
Because of higher levels of inflation, as of today the expectation is that the Fed will only have two further interest rate cuts in 2025. Previously, the expectation was that there would be three rate cuts. This has implications for the average consumer who wants to buy anything that needs financing including a house, a car, a home improvement or a large appliance. And it has implications for businesses that invest in machinery, other expansions, or any new projects that require financing.
The U.S. economy has been remarkably resilient, including a strong retail sales report last week showing that despite persistent inflation, consumers are still spending. As such, there is now some question on whether the Fed should continue to incentive spending through lower interest rates. This makes the number of future cuts hard to forecast. As of right now, it appears we will be at a roughly 4% Fed Funds rate by the end of 2025, which is still a full percentage point above what’s called the neutral rate of 3%.
But the other murky aspect of this is the new administration’s policies. I believe we will have a record number of executive orders in the first 30 days of the Trump administration simply because he knows the job, the agencies, and what he wants to do. Those executive orders could have large impacts on the U.S. economy in a relatively short period of time and, if so, large impacts on Federal Reserve rate decisions.