Markets fell sharply on Wednesday after the Federal Reserve signalled it would make fewer rate cuts than had been expected in 2025, amid worries over ‘stubborn’ inflation. The Fed cut the federal funds rate to between 4.25 per cent and 4.5 per cent in its final rate decision of the year but spooked investors after Fed chief Jerome Powell warned inflation would remain higher than expected in 2025. Some observers have questioned whether the euphoria over President-Elect Trump’s election win is over, or if the markets are poised to rebound bigger than ever before.

The US economy remains strong

The latest US economic data shows the fundamentals remain strong. While inflation remains above The Federal Reserve target of 2 per cent, it has fallen dramatically since prices soared two years ago. The November jobs report showed the US added 227,000 jobs, including tens of thousands of new roles in the transportation equipment and manufacturing sectors. However, investors are worried that inflation has yet to be brought to heel, and some think it could be exacerbated by new tariffs levied on key US trading partners such as Mexico, Canada and China.

Fed chief Jerome Powell has blamed sticky inflation on a shift away from Chinese imports in recent years but has so far declined to comment on the potential impacts of a fresh wave of trade barriers. But it speaks to Powell’s caution that fielding questions from reporters on Wednesday he refused to rule out the possibility of hiking rates next year, telling journalists: “You don’t rule things completely in or out in this world,”

Stocks slide after rate cuts stalled

The Dow Jones closed 2.58 per cent down on Wednesday, its 10th consecutive losing day – the most since 1974 – after investors learned there would likely be fewer rate cuts next year than had been anticipated. The S&P 500 was down 3 per cent and the Nasdaq was down 3.6 per cent. Some analysts fear that a combination of tariffs and tax cuts could put a fresh fire under inflation. As the BBC reported:

“Analysts have also warned that policies backed by President-elect Donald Trump, including plans for tax cuts and widespread import tariffs, could put upward pressure on prices.

“Analysts say lowering borrowing costs risks adding to that pressure by making it easier to borrow and encouraging businesses and households to take on credit to spend. If demand rises, higher prices typically follow.

“Mr Powell defended the cut on Wednesday, pointing to cooling in the job market over the last two years.”

A number of industry experts have voiced their concerns over new tariffs fuelling inflation, including Lindsy James of Quilter Investors who said trade barriers, immigration restrictions and tax cuts “are expected to see a shallower path of easing in future months.”

Who benefits from a rate cut?

An extended period of high interest rates has been blamed for record consumer defaults and a soft credit crunch, as borrowers have struggled to service their debts. Many borrowers with variable loans will benefit from Wednesday’s decision, including those with personal loans and credit card debts.

There could also be an opportunity for investors as rates are wound down, as stocks tend to do better when interest rates are low. Following the latest interest rate cut Bankrate chief financial analyst, Greg McBride said:

“Another interest rate cut is welcomed by stock investors, especially when coupled with the ongoing strength in the economy, growth in corporate earnings and optimism for a favourable backdrop in 2025,

“With the stock market near record highs and speculation rampant, it is hard to argue that Fed policy is restrictive.

“But concerns about inflation haven’t gone away and there are worries it may flare up again in 2025. This is why we’re seeing short-term bond yields follow the Fed lower at the same time intermediate- and long-term bond yields have been on the rise.”

Will Trump drive inflation up?

Among President-Elect Donald Trump’s pledges to voters during the election campaign was the promise to bring down prices. And while many observers say trade barriers and tax cuts will safeguard key industries and spur economic activity, others warn they could mean pushing up the cost of goods and services even higher. Speaking to the FT, the economist Derek Tang said:

“People may be under-weighting the scenario where the labour market does weaken and the Fed is now caught between higher inflation but also trying to stop the economy from entering a recession,”

The outlet reported that: “Trump’s threats to impose tariffs, carry out mass deportations and slash taxes and regulations could have wide-ranging economic implications, said investors and analysts. Some economists are concerned that the overhaul will lead to higher inflation, lower growth and more volatility.”

Analysis by Goldman Sachs anticipates that the impact of Trump’s tariffs would result in a fall in inflation, but at a slower rate than was previously expected, dropping to 2.4 per cent by the end of 2025. Other commentators cite the counteractive forces of planned cuts to the federal government, notably through the DOGE initiative. The Daily Telegraph’s Business Editor argued the inflationary impact of new tariffs would be limited. In a November article, he said:

“Strictly speaking, Trump’s tariffs are not inflationary. They are a “one-off jump in the price level”, as the Federal Reserve’s staff argued in a 2018 study modelling the effects of 15pc tariffs across the board.

“The Fed advised looking through the “temporary” effects, just as it looks through an oil shock. The study concluded that tariffs on that scale (plus retaliation) would be a recessionary shock for the US economy and therefore should be offset by lower interest rates – the exact opposite of conventional wisdom…

“The assault on the US government being prepared by Elon Musk and the tech brotherhood of Hayekian hard-Right billionaires will outweigh the demand stimulus from lower taxes, ushering in a 1920s era of retrenchment and small government – a latter-day version of Calvin Coolidge, who also threw the world economy into convulsions with a lethal mix of closed trade and open capital flows.”

What will inflation be in 2025?

As 2025 approaches, the trajectory of U.S. inflation remains a focal point for policymakers, investors, and consumers. Recent projections from the Federal Reserve suggest that inflation will persist above the 2 per cent target, with expectations of a 2.5 per cent rate by the end of 2025.

This anticipated persistence of inflation is influenced by several factors. The implementation of new tariffs under the incoming administration is poised to elevate import costs, thereby exerting upward pressure on consumer prices. Additionally, a robust labour market, characterized by low unemployment and rising wages, may further contribute to inflationary pressures as consumer spending strengthens.

In response to these dynamics, the Federal Reserve has signalled a more measured approach to monetary easing. While two quarter-point rate cuts are projected for 2025, bringing the federal funds rate to a range of 3.75 per cent to 4.00 per cent, this represents a slower pace of reduction than previously anticipated.

This cautious stance reflects the Fed’s commitment to balancing economic growth with price stability, aiming to prevent the economy from overheating while avoiding a premature tightening that could stifle expansion.

Market reactions to these developments have been pronounced. Equity markets have experienced volatility, with significant declines in major indices following the Fed’s announcements. Bond markets have also responded, with rising yields indicating investor concerns about persistent inflation and the potential for more aggressive monetary policy adjustments if inflation does not moderate as expected.

Looking ahead, the interplay between fiscal policies, such as tariffs and tax reforms, and monetary policy will be critical in shaping the inflation landscape. While the economy exhibits resilience, the persistence of inflation above target levels suggests that both policymakers and investors should remain vigilant. Strategic adjustments in response to evolving economic indicators will be essential to navigate the complexities of the 2025 economic environment.