Fed’s easing path to set tone for markets in 2025

Video: Year ahead – How to capitalize on falling rates in 2025 (9:30)
Video: Year ahead – Where can investors position in stocks?(10:40)

The Federal Reserve is widely expected to announce its third interest rate cut of the year at the end of today's policy meeting. This would bring the target range of its benchmark overnight rate to 4.25-4.50%, 100 basis points lower than when it began this easing cycle in September.

What the US central bank does after today’s rate reduction, however, remains an open question. Recent data showed that economic growth in the US remains resilient, with retail sales in November above consensus and the flash composite PMI for December signaling the fastest expansion of business activity since March 2022. Uncertainty over President-elect Donald Trump’s tariff and fiscal policies also complicates the outlook.

With the Fed’s decision and its easing path ahead likely to set the tone for global financial markets in the year ahead, we discuss some key things investors will be watching closely today and beyond.

The “dot plot”: Alongside the interest rate decision, the Fed will publish its quarterly economic projections that include a dot plot showing how far and fast policymakers expect rates to fall. The dot plot in September implied 100 basis points of cuts in 2025, but markets have since pared back expectations to around 70bps of easing amid a solid economy and concerns that inflation could re-accelerate under a second Trump presidency. Investors will also be looking out for the Fed’s latest forecasts on growth and inflation.

Comments by Fed Chair Jerome Powell: While the dot plot is likely to give a framework on the path of the Fed’s monetary policy, Powell has in the past downplayed the guidance. With President-elect Trump’s yet-to-be-detailed policies the biggest known unknown in the year ahead, markets will be looking to Powell’s comments at the post-meeting press conference in search of clues about how the Fed would integrate potential tariffs, tax cuts, and deregulation effects into its assessment of the economy and its policymaking process. A hawkish Powell would likely trigger market volatility in the near term.

Inflation and other economic indicators: We believe the Fed is ultimately data-dependent, and future economic indicators will continue to play a significant role in shaping the US central bank’s next steps. The Fed’s preferred gauge of inflation, the personal consumption expenditures (PCE) price index, is due later this week on Friday, and we expect overall inflation to moderate further in the months ahead. Jobs data will also remain an important consideration as the Fed continues to assess the health of the labor market.

Overall, we believe investors should anticipate a deceleration in the pace of rate cuts in 2025 and near-term volatility as markets recalibrate the Fed’s standpoint. Still, a mixture of resilient US activity, lower borrowing costs, a broadening of US earnings growth, further AI monetization, and the potential for greater capital market activity under a second Trump administration creates a favorable backdrop for US equities, in our view. We expect the S&P 500 to hit 6,600 by the end of next year and see scope for underallocated investors to use any near-term turbulence to add to US stocks, including through structured strategies.

Investors should also deploy excess cash into high-quality and diversified fixed income strategies, select equity income strategies, and structured investment approaches. These can offer income generation and portfolio diversification, as lower interest rates will likely erode returns on cash next year.

We also see merit in diversifying with alternative investments, including hedge funds and private markets. For example, equity market neutral hedge funds stand 10.2% higher year-to-date, on course for the best annual performance since 2000 (based on HFRI EH: Equity Market Neutral Index data). We like this strategy, as it would be well placed if US political uncertainty and investor reassessment of the Fed's path drive sharp rotations between sectors, factors, and stocks in 2025. Investing in alternative assets comes with unique risks, including but not limited to illiquidity.