Fed May Cut Rates More Than Expected in 2025, State Street Says
State Street predicts the Federal Reserve may deliver more interest rate cuts in 2025 than the market anticipates. This forecast is based on several factors conducive to a more accommodative monetary policy.
Improved US Financial Health
Enhanced US financial well-being could mitigate yield pressure on bonds, facilitating future rate cuts. State Street's Michael Arone expects the deficit to improve by $300-$400 billion this fiscal year due to increased tax revenue and decelerating entitlement spending. This will reduce pressure on bond yields and provide markets with relief from rising rates.
Disinflationary Trends
Disinflation is anticipated to resume after a temporary halt in recent months. This is partly driven by easier year-over-year comparisons and cooling indicators, such as owners' equivalent rent. Lower inflation expectations will give the Fed more leeway to cut rates.
Economic Growth Cool-Down
Economic growth is expected to decelerate in 2025 after robust expansion in 2023 and 2024. This could cast doubt on the health of the US economy, further pushing down Treasury yields. A slowing economy typically warrants lower interest rates to stimulate growth.
Market Implications
Arone predicts the Fed will cut rates at least twice in 2025, but potentially three or more times, surpassing market expectations. This could result in the target range for the federal funds rate falling below the Fed's preferred inflation measure, creating room for further cuts.
Overall, State Street's analysis suggests that investors may need to adjust their assumptions about Fed policy in 2025, with more rate cuts than currently anticipated being a distinct possibility.