What to Expect From the Federal Reserve's Interest Rate Decision Next Week

As the Federal Reserve prepares to make its final interest rate decision of 2024, investors are eagerly awaiting the central bank's next move. With inflation still running hot and economic growth remaining robust, the Fed faces a delicate balancing act in managing monetary policy. Here's what to expect from the Fed's decision next week and its potential impact on various sectors of the economy.



Inflation and Economic Growth

The Fed's primary mandate is to maintain price stability, typically defined as an inflation rate of 2% per year. However, inflation has been running hotter than expected, with the consumer price index (CPI) rising 2.7% year-over-year in November 2024. This is above the Fed's target, and if inflation continues to rise, the Fed may decide to raise interest rates to cool the economy and bring inflation back down to target.

At the same time, gross domestic product (GDP) growth has been strong, with the Fed projecting a growth rate of 2.5% for 2024 and 2.2% for 2025. Strong economic growth can lead to increased demand for goods and services, which can put upward pressure on prices. If GDP growth remains robust, the Fed may decide to raise interest rates to prevent the economy from overheating.

Unemployment and Tariffs

The Fed's second mandate is to promote maximum employment. The unemployment rate has been relatively stable, with the Fed projecting it to remain around 3.5% in 2024 and 2025. If the unemployment rate starts to rise, the Fed may decide to lower interest rates to stimulate the economy and bring unemployment back down.

However, President-elect Trump has proposed implementing tariffs on imports from Mexico, Canada, and China. If these tariffs are enacted, they could increase the cost of goods for American consumers, potentially leading to higher inflation. The Fed may decide to raise interest rates in response to these inflationary pressures.

Market Expectations and Fiscal Policy

Investors' expectations for future interest rate hikes have been rising, with about 58% of investors expecting at least one hike following the Fed's June 2022 meeting. If market expectations for rate hikes continue to rise, the Fed may decide to raise interest rates to manage market expectations and prevent the economy from overheating.

Additionally, the incoming Trump administration has proposed a range of fiscal policies, including tax cuts and increased government spending. These policies could have an impact on the economy, potentially leading to higher inflation or faster economic growth. The Fed may take these fiscal policies into account when making its decision on interest rates.



Impact on Housing, Consumer Spending, and Business Investment

The Fed's decision next week to cut interest rates by 0.25 percentage points is expected to have a modest impact on various sectors of the economy. Lower interest rates make mortgages more affordable, which could boost demand for housing and support home prices. However, the Fed's projections for a slower pace of rate cuts in 2025 may limit the extent to which mortgage rates decline, as mortgage rates are influenced by broader economic trends and changes in the yield for the U.S. 10-year Treasury bond.

Lower interest rates also make borrowing cheaper, which could encourage consumer spending on credit cards and other debt. However, the Fed's decision to cut rates less aggressively in 2025 may limit the extent to which consumer borrowing costs decline, which could impact consumer spending.

Lower interest rates also make borrowing cheaper for businesses, which could encourage investment in new equipment, facilities, and other capital expenditures. However, the Fed's projections for a slower pace of rate cuts in 2025 may limit the extent to which business borrowing costs decline, which could impact business investment. Additionally, the Fed's projections for higher inflation in 2025 may increase uncertainty for businesses, which could impact their investment decisions.

In conclusion, the Fed's decision next week is likely to have a modest impact on various sectors of the economy, such as housing, consumer spending, and business investment. However, the Fed's projections for a slower pace of rate cuts in 2025 may limit the extent to which these sectors benefit from lower interest rates, and may also introduce uncertainty that could impact investment decisions. Investors should pay close attention to the Fed's decision and its impact on the yield curve to make informed investment decisions.