The US Federal Reserve has cut interest rates three times this year, and there’s a consensus among Wall Street analysts that two more rate cuts are likely in 2025. This move comes as inflation, measured by the Consumer Price Index (CPI), is trending towards the Fed’s target of 2%. The central bank has been reversing its tight policy since September, with the latest cut being in November.
The decision to lower interest rates is a response to the COVID-19 pandemic, which triggered a cocktail of inflationary pressures. However, pandemic-related supply chain issues were mostly resolved in 2023, and combined with higher rates, the annualized increase in the CPI fell to 4.1%. As of October 2024, the CPI stands at an annualized rate of 2.6%, close to the Fed’s target.
The US economy has shown surprising resilience despite higher interest rates. However, cracks are appearing, and a further deterioration in the jobs market might lead to slower consumer spending. The unemployment rate has ticked higher from 3.7% in January to 4.1%.
A recession is not currently indicated by economic data, but investors should monitor any weakness in the jobs market next year. Falling rates can be great for stocks as they reduce debt servicing costs and increase borrowing power, leading to more spending on big-ticket items.
However, there are caveats. The S&P 500 is near delivering back-to-back annual returns of over 20%, which has only happened a handful of times since 1957. Its valuation is now far above historical norms. Additionally, the incoming Trump administration’s economic policy will focus on tariffs, which may derail the stock market rally.
Despite this, history proves that the S&P 500 always recovers to new highs eventually. A correction from here could easily turn into a bear market if investors fear a trade war, but falling rates might not be as beneficial for stocks in 2025 as they were in previous cutting cycles.
Source: https://www.fool.com/investing/2024/12/07/the-fed-cut-interest-rates-2025-wall-street-stocks