INSIGHTS

On January 08, 2025

The Big Picture: What's Next?

Inflation still a Fed concern

The U.S. Federal Reserve (Fed) cut interest rates by a quarter-point on December 18, 2024, as expected, amounting to a cumulative full-point reduction since September 2024. Instead of celebrating, the market reacted like it received a lump of coal in its Christmas stocking, as Fed Chairman Jerome Powell telegraphed a slower and shallower rate cut narrative for 2025. While the Fed had done a lot to support the economy over the last 90 days of 2024, policymakers wanted to see more progress on inflation before guiding to further reductions. The updated Statement of Economic Projections (SEP) is indicating only 50 bps (basis points) of cuts forecast for 2025. Inflation — as measured by the Personal Consumption Expenditures Price Index (PCE) — is now forecast to be much higher at 2.5% in December 2025, up from 2.1% as previously thought, as disinflation has stalled. These data points have led investors to believe that it may take until 2026 for inflation to approach 2%, pushing out the timeframe by a year for inflation to get back to the Fed’s target.

Fed rate cutting cycles typically drive Treasury yields lower, but that was not the case in 2024. Since the date of the first Fed rate cut on September 18, 2024, the 10-year U.S. Treasury yield rose by 80 bps to 4.5%. This increase was driven by the fact that there had been no credible signs of an economic slowdown. The Fed deserves credit for executing a soft landing, in our view. Powell noted that “most forecasters have been calling for a slowdown in growth and it keeps not happening. There is no reason to think a downturn is more likely than it usually is.”  In fact, the U.S. economy favorably contrasts with economic conditions around the world, particularly in Europe which is teetering near a recession.

The road ahead

Investors are left to wonder what’s next. Do we see 50 bps of cuts in 2025, or do we start the year with Treasury yields moving higher as they did in the first quarter of 2024? While many fear the new U.S. administration’s policies could be inflationary, causing the Fed to stop cutting rates, many of the new speculated-upon policies would take time to implement and work their way through the economy. As President-elect Trump walks into the White House, the Fed may take pause, suggesting that Fed governors may have pre-emptively considered the impact of Trump’s tariff, tax, and spending proposals. Deregulation and tax cuts could potentially provide a boost to U.S. economic growth and benefit domestic companies, encouraging a risk-on environment for investing. For now, the economy remains resilient, with labor productivity gains providing a structural tailwind that supports growth. We believe this constructive fundamental backdrop, combined with a lack of material debt maturities for several years, should keep credit stress and default rates modest.

In short, we expect 2025 to be similar to 2024 with growth at 2.0-2.5%, inflation running close to 3% and the Secured Overnight Financing Rate (SOFR) base rate at or north of 4.0%, resulting in default rates remaining stable and concentrated in a small group of industries.

CRN: 2025-0108-12204 R