After several years of sustained interest rate hikes, the Federal Reserve began cutting the Federal Funds Rate in September.
Consumers welcomed this change, as many experts anticipated several rounds of planned interest rate cuts would finally bring down the cost of borrowing, particularly for mortgages.
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However, heightened political uncertainty and resurgent inflation put upward pressure on interest rates, leading the Fed to evaluate its planned rate-cut pace through 2025.
It’s now widely believed that the Fed will reduce interest rates twice this year, in June and then in either September or December. Fresh Fed inflation forecasts come in June, which could change the calculation.
Related: Fed inflation gauge shows early tariff impact
Holding interest rates until inflation comes down and assessing the impact of the Trump administration’s trade and tariff policies provide a practical approach, but even holding steady on rates might have some downsides.
We spoke with Kristina Hooper, chief global market strategist at Invesco, about the Fed’s current approach to interest rates, how it might evolve throughout the year, and the implications of waiting to adjust its policy.
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Fed might hold current rates through Q3
CME FedWatch sees a 12% chance of an interest rate cut at the May Board of Governors meeting. However, that probability jumps to 55.7% for the June Fed meeting, and the potential for another rate cut in September stands at 39.5%.
Whether the Fed cuts rates at all over the next few months will depend largely on how inflation progresses and whether the labor market remains strong.
“The Fed has made clear that it will take a wait-and-see approach,” Hooper said. “We’ve made a lot of disinflation progress, but it remains to be seen whether we can make more, especially given policy uncertainty and what the impact of certain policies could be.”
More on interest rates:
- The surprising reason mortgage rates are up despite interest rate cuts
- Fed chair Jerome Powell issues warning on inflation, weak housing market
- Dave Ramsey shares a major mortgage, interest rate strategy now
After the Fed’s most recent rate cut, in December, Chairman Jerome Powell said the central bank would take time to evaluate how the economy — and inflation in particular — would react to a new presidential administration.
“Right now, the labor market is strong, but that could change and may also push the Fed in a different direction,” Hooper said. “So I think we’re likely to see a Fed that doesn’t do anything probably until late in the second quarter, early in the third quarter.”
Powell recently noted that the impact of Trump’s proposed tariffs on Canada, Mexico and China will be closely monitored. The Trump administration also unveiled plans for a 25% tariff on all automobiles and auto parts manufactured outside the U.S., a policy that is likely to boost inflation.
“But the reality is the current monetary policy is restrictive, and the Fed will admit that it doesn’t know exactly what policies are going to do this year,” Hooper said.
“So they’ll take advantage of the luxury we have to sit and watch the data. So this is the ultimate data-dependent environment for the Fed.”
Wait-and-see rate approach has downsides
Waiting to see how the economy responds to change and instability is strategic but doesn’t come without downsides. The longer the Fed waits to seek clear economic data to shape its policy, the more reactive markets will be when a change occurs.
“I think the Fed feels as though it’s in a place now with many tools at its disposal, and it can move in either direction depending upon the data,” Hooper says. “You might ask, ‘Will the stock market be comfortable with this?’ And I think the stock market has been quite resilient at the end of the day.”
Related: The White House will take surprising approach to curb mortgage rates
The S&P 500 is down 5% this year. Uncertainty is one of the biggest drivers of market volatility, and the longer the Fed’s plan of action remains in the air, the longer market volatility will persist.
“But we have to assume that it will react more to data points because it knows the Fed is so dependent,” Hooper explained.
“So, I would anticipate an environment of heightened volatility, more of an outsized reaction to data points, including consumer inflation expectations.
“I think that’s gone up a lot. I think it has the power to impact the Fed’s thinking. And so markets could very well react to those prints as well.”
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