The turn of the calendar has many people resolved to make a positive change, while a few are resigning themselves to eschew the resolutions and embrace their everyday selves. Interest rates are in the latter camp. This time last year, market expectations of rate cuts were “New Year, New Me,” with futures markets pricing in 1.5% of cuts steadily throughout the year. No change came until September, and after only 1% of cuts for 2024, market expectations of interest rates slimming down by beach season 2025 are subdued.
Higher For Longer is the theme that has slowly been taking hold for the last year and is borne out by Fed Funds futures prices¹ today, coalescing around less than 0.5% of total rate cuts for 2025. Minutes from December’s Fed meeting released this week showed that the final rate cut last month was a close call, with some members preferring to leave rates unchanged. This highlights the push and pull of the Fed’s dual mandate, to maintain price stability (avoid high inflation) and maximum employment. When we zoom out and review the last year of Fed activity, it’s clear that the Fed is more worried about reigniting inflation by cutting rates too soon than by allowing a recession by cutting too late.
Homebuyers are the group that most acutely feels the effects of higher rates. Two profiles must confront the reality of 6-7% mortgages that now have a two-year track record: first-time homebuyers who hoped to enjoy the same 3% mortgages their older siblings originated, and existing homeowners who love their low rate but have fallen out of love with their current home. Our advice to both is like any homebuyer in history- live within your means. The last two years have proved that waiting to be bailed out by lower rates can be a difficult proposition. All the while, housing prices have ticked up with inflation, and any move downward in rates from here will surely be met by buyers capitulating and happy to transact below the 7% threshold that has held down recent activity.
Savers are the winners in this higher-for-longer rate environment. The yield curve today is largely normalized and all maturities of US debt are yielding between 4-5%. This relatively high risk-free rate of return has kept cash on the sideline, and savers can patiently clip coupons and cheer for a market correction.
Investors can hope to look to 2025 as the first year since the pandemic that Federal Reserve activity is not a dominant theme. Given the subdued expectations for the Fed Put this year, market price discovery will have to be led by good old corporate fundamentals, even in this higher-for-longer environment.
- FedWatch (CME Group) https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
