How will the pace of economic growth influence monetary policy?
The economy’s strength is a major consideration as the Federal Reserve (Fed) calibrates monetary policy. In September, the Fed cut the federal funds target rate (the rate charged by financial institutions to lend funds overnight to each other), for the first time in four years. Another rate cut occurred in November, with markets anticipating a third cut in December.3
However, based on minutes of the Fed’s November 2024 meeting, it was noted that Fed policymakers deem “it appropriate to reduce policy restraint (interest rates) gradually.”4 That could temper expectations around the pace of rate cuts in 2025.
The Fed’s rate cuts are designed to impact the broader economy. Fed Chair Jerome Powell stated that “As inflation has declined and the labor market has cooled, the upside risks to inflation have diminished and the downside risks to employment have increased.”5 However to this point, the jobs market appears to be holding its own, with the unemployment rate just above 4% and new weekly jobless claims considered to be at manageable levels.6
“Capital markets are pricing in expectations of better economic growth,” says Rob Haworth, senior investment strategy director for U.S. Bank Asset Management. “We’re seeing that in continued upward movement for stocks and rising 10-year Treasury bond yields.” Although the Fed cut short-term rates, 10-year Treasury yields moved up from a low of 3.63% in mid-September (when the Fed began cutting rates) to a peak of 4.44% less than two months later.7 Yields have remained in a trading range since. Rates moved up on other long-term bonds as well, complicating matters for businesses, particularly as it relates to business capital investment. Nevertheless, corporate capital expenditures remain solid to this point.
Can the economy stay on track?
“Modest, steady economic activity continues to be the path we appear to be on at this point, with no serious recession risk,” says Haworth. He believes ongoing labor market strength is the key variable that could impact consumers. “A sudden jump in layoffs would be a negative signal, but we’re not seeing that,” says Haworth. “Employers are hanging on to workers, particularly in areas where they struggled to fill positions before.” says Haworth.