The Federal Reserve left interest rates unchanged at 5.25% to 5.5% after their latest meeting on Wednesday, June 12. It pushes the prospect of rate cuts this year to as late as December – if they are to come at all, with Chair Jerome Powell signalling he was content not to rock the boat. Today’s outlook stands in stark contrast to analyst expectations coming into the year, when the consensus opinion was borrowing costs would be slashed several times.

 Those hopes were dashed when fresh fears of inflation were sparked after higher-than-expected price rises revealed in April. The inflation threat, which appears to have subsided, prompted Larry Summers to speculate a rate rise was no longer off the table this year.

Nigel Green, CEO of one of the world’s largest independent financial advisory and asset management organisations, warned in May that there was a real prospect that rates would remain unchanged until 2025. Commenting, he said:

“We believe that the cautious US central bank officials will need several consecutive months of evidence showing inflation is heading back to the 2% target before they pivot on monetary policy. Therefore, as it stands, there’s a considerable risk that they will not feel comfortable about cutting rates before 2025.”

Will the Fed cut interest rates in December?

The Federal Reserve is set to meet to decide on interest rates four more times before the end of the year, in July, September, November and December – and has revised its outlook downward to a single cut this year.

Analysts expect if a rate cut is coming this year, sooner is less likely than later. As per reporting by CNN, Bankrate’s Greg McBride said in a recent note that:

“There has been little in the way of measurable improvement in inflation since the Fed’s May meeting, so the prospect and timing of any interest rate cut remains unclear. Absent a complete about-face from the economy, interest rates aren’t likely to come down soon enough, or fast enough, to provide meaningful relief to borrowers.”

While there is uncertainty over whether a rate cut will arrive in 2024 – many observers are now confident there won’t be as many as two. Speaking to BBC’s Today Programme, Anastassia Fedyk, assistant professor of finance at Berkeley, said:

“We did get some good news in terms of better inflation numbers. But the Fed is still being pretty cautious, so they are signalling that in the future, they will be doing one, most likely, rate drop and not a very large one at that.”

Why is the Fed keeping rates steady?

The Federal Reserve remains jittery about inflation. The Fed has a duty to walk a tightrope between stimulating the economy and keeping a lid on price rises. Perhaps spooked by the 2.8% rise in core PCE in March, the Fed determined its overriding obligation remains to stamp out inflation for good. Issuing a statement following Wednesday’s unanimous decision to hold rates, a spokesperson for the Federal Reserve said:

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been modest progress toward the Committee’s 2% inflation objective…

In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%…

Additionally, the Committee will continue reducing its holdings of Treasury securities agency debt and agency mortgage-backed securities. The Committee is strongly committed to returning inflation to its 2% objective.”

As recently as March, officials at the Fed were still signalling there would be as many as three rate cuts before 2025; however, after Wednesday’s meeting, that was revised down to just one on the so-called ‘dot-plot’, with four of nineteen officials predicting no change this year.

How will high interest rates impact the economy?

High interest rates make it more expensive to borrow money. That means consumer borrowers can face higher repayments – with recent months seeing record defaults and warnings over a credit crunch – and higher bills for the government in servicing its debt.

The net interest costs on US debt are projected to rise significantly over the next decade, from a projected $870 billion this year to $1.6 trillion by 2034, according to analysis by the Peter G Peterson Foundation. They say that on current forecasts, debt interest costs will exceed the defence budget this year, and by 2054, comprise more than one-third of government spending.

Those levels of payments are widely considered unsustainable – and would mean less money for the government to spend on public programmes, and may force it to raise taxes as a means of increasing revenue. However, some analysts believe that without urgent intervention, nothing will prevent a default by the middle of the century. Modelling by the University of Pennsylvania suggests that:

“The United States has about 20 years for corrective action, after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt. Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.”

One leading analyst said a US debt default would “Make the global financial crisis look like a tea party”, while others have described the prospective ‘doomsday’ scenario – which most still consider unlikely – as ‘cataclysmic.’

Will the Fed cut rates in 2025?

Policymakers are currently anticipating several rate cuts in 2025, with interest rates coming down toward 4%, as per Reuters. And while the optimism around rate cuts might have been snubbed by stubborn inflation over recent months – the Fed’s hand may be forced next year.

One strategist has said rate cuts will become all but inevitable in 2025 as the country risks seeing record consumer defaults. Speaking to CNBC, the head of investment strategy at State Street, Altaf Kassam, said:

“The problem is, if rates stay at this level until say, 2025, when a big wall of refinancing is due, then I think we will start to see more things break. For now, consumers and corporates aren’t feeling the pinch of higher interest rates.”

Estimates for the target rate now stand at, between 3.75% to 4% by the end of 2025, and between 3% and 3.25% by the end of 2026 – an increase on previous expectations.

What does the Fed take into account when setting rates?

When the Federal Reserve sets interest rates, it undertakes a complex balancing act, taking into account various economic factors and often navigating conflicting goals. The Fed’s primary mandate, as outlined by Congress, is to promote maximum employment, stable prices, and moderate long-term interest rates. Here are the key considerations and the potential conflicts it must manage:

One of the primary considerations for the Fed is the trade-off between stimulating economic growth and controlling inflation. Lower interest rates reduce borrowing costs, encouraging businesses to invest and consumers to spend, stimulating economic growth. However, if the economy grows too quickly, it can lead to inflation, where prices for goods and services rise too fast. High inflation erodes purchasing power and can destabilise the economy, so the Fed must carefully manage interest rates to avoid this outcome. Conversely, if the Fed raises interest rates too much to control inflation, borrowing costs increase, dampening economic activity, leading to slower growth or even a recession.

The Fed also must consider the state of employment when setting interest rates. Lower interest rates can help reduce unemployment by making it cheaper for businesses to borrow and expand, thereby creating jobs. However, achieving maximum employment can sometimes conflict with the goal of stable prices. For example, if the labour market is too tight, with very low unemployment, wages might rise rapidly, leading to higher overall inflation.

Global economic conditions also play a significant role in the Fed’s decision-making process. In an interconnected world, international economic developments can impact the U.S. economy. For instance, if major economies are experiencing slow growth, it can affect U.S. exports and financial markets. Additionally, the relative strength of the U.S. dollar, influenced by interest rates, affects international trade and investment flows. A strong dollar can make U.S. exports more expensive and less competitive, while a weak dollar can boost exports but increase the cost of imports.

Financial stability is another critical consideration. The Fed must be cautious about the potential for creating asset bubbles—situations where the prices of assets like real estate or stocks become inflated beyond their intrinsic value due to excessively low interest rates. If they burst, these bubbles can lead to severe economic disruptions.

The Fed’s decisions are also influenced by public and market expectations. Managing these expectations is crucial for maintaining economic stability. Clear communication about monetary policy intentions helps to avoid sudden market reactions that can destabilise the economy.

Moreover, the Fed must navigate political pressures. Although it operates independently, its decisions can have significant political implications. Balancing short-term political considerations with long-term economic health is a challenging aspect of its role.

In summary, when setting interest rates, the Federal Reserve must weigh the goals of stimulating economic growth, controlling inflation, maintaining maximum employment, ensuring financial stability, and considering global economic conditions. These considerations often present conflicting goals, requiring the Fed to carefully balance its actions to promote overall economic well-being.