Is the Fed Steering the U.S. Economy and Stock Market?

This week’s MOTM explores why the Fed’s rate moves might not define the markets in 2025

Are the U.S. Economy and Stock Market in the Fed’s Hands Now? The Federal Reserve made some waves at the end of last year. The 25 basis-point rate cut they announced at their December meeting was widely expected. What the market was not expecting, however, was the insinuation that rates may not necessarily follow the downward trajectory the Fed had previously projected. The one particular comment that jolted markets appeared to be when Chairman Jerome Powell said: “From here, it’s a new phase, and we’re going to be cautious about further cuts.” Cautious about further rate cuts? Wasn’t the inflation fight largely won, with the benchmark fed funds rate destined to fall back to a neutral rate in the 3% to 3.5% range? The financial media and investor community were aghast at the news. My advice to investors: do not overthink or overstate the importance of rate cuts in 2025. The economy and markets can do just fine with or without them. Market Insights to Guide Your 2025 Strategy 2024 was a year of surprises that shaped today’s markets—global conflicts, inflation trends, and the U.S. presidential election all played pivotal roles. Understanding these factors is crucial to crafting a winning investment strategy for the year ahead. Our Zacks 2024 Year in Review 1 offers a deeper dive into these transformative events, delivering expert insights and actionable takeaways. Inside, you’ll discover: The underappreciated “Goldilocks” U.S. economy Easing monetary policy in Q3 Key market-moving political events And much more! If you’re investing $500,000 or more, download your free report today to gain expert insights and prepare for the year ahead! Download Our Exclusive “Zacks 2024 Year in Review” 1 Just take 2024 as your prime example. At the end of 2023, futures markets were forecasting six or more rate cuts for 2024, which turned out to be quite wrong. As it turned out, the Fed cut rates three times during the year, lowering the fed funds rate to a range of 4.25% to 4.5%. The economy and stock market did not seem to mind the ‘higher-for-longer’ level of rates, with GDP growth coming in strong and stocks rallying more than +20%. If we know the economy and stock market can perform well even with the benchmark fed funds rate north of 4.5% or even 5%, then why would a 4% level of rates somehow be prohibitive to growth? Fed officials projected at the December meeting that rates would finish 2025 at 3.9%, which is one fewer cut than they had suggested at the September meeting. Investors who are up in arms over this news are missing the big picture, I think. I do not see 25 basis points in either direction as a very meaningful move. The big debate in markets now is where the so-called “neutral rate” is for benchmark fed funds. The neutral rate is a moving target depending on economic conditions—it’s the rate of interest that sustains the economy at full employment with stable inflation. In other words, the interest rate that keeps the economy not too hot, and not too cold. If consumers and businesses are borrowing and spending too much, and inflation starts to tick higher again, it likely means rates are too low. If the jobs market is loosening and lending activity is tepid, rates may be too high. If you want to know exactly where the Fed sees the neutral rate today, you will not get a clear answer from Chairman Powell. After the December meeting, he said: “We don’t know exactly where it is, but … what we know for sure is that we’re a hundred basis points closer to it right now.” Some Fed officials think it’s closer to 3%, some say it’s 4%. Perhaps it’s somewhere in between. The point I’d repeat here is that I’m not sure the level of rates matters as much as many think. The idea that the U.S. economy and the stock market’s fate are in the Federal Reserve’s hands—and hinges on whether they get the neutral rate exactly right—is simply not substantiated by what we know from history, or even from 2024 for that matter. Interest rates remained ‘higher-for-longer’ all year, and stocks powered higher. Monetary policy decisions are not meaningless, of course, but my argument here is that they are not as important as many investors assign them to be. In my view, what would hurt markets most is if inflation and inflation expectations start to drift higher and become un-anchored from their current 2.5% to 3.5% level, perhaps because of some unforeseen shock in geopolitics or the global economy. If the Fed is forced to go in the other direction—raising rates instead of cutting them because of a negative inflation surprise—I think that could be very detrimental to stocks. For now, however, inflation data continues to show modest progress toward the Fed’s long-term goal. In November, the Fed’s preferred inflation gauge—the PCE price index—came in at 2.4% year-over-year, well within striking distance of the target. Bottom Line for Investors With inflation hovering near its target and the unemployment rate at 4.2%, there is little expectation that interest rates will go any higher. Whether or not they go lower, and by how much, is an ongoing debate. But it’s not one I think investors should be focused on. If you spend too much time framing your market and economic outlook around shifting expectations for interest rates, it may mean de-emphasizing stocks’ main driver—earnings growth. By understanding 2024’s market surprises, you can unlock valuable insights to stay ahead and capitalize on opportunities in 2025. Our Zacks 2024 Year in Review 2 goes beyond the headlines, analyzing the year’s most pivotal market shifts and their potential impact on the future. This comprehensive guide offers expert analysis of: The underappreciated “Goldilocks” U.S. economy Easing monetary policy in Q3 Key market-moving political events And much more! This exclusive report is your strategic roadmap for navigating today’s market and positioning yourself for success in 2025. If you have $500,000+ to invest, don’t miss this opportunity to gain a strategic edge! About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. The end result is investment management that is research driven, results oriented and client focused. Talk to a Zacks Wealth Advisor today. © Zacks Investment Management  |  Privacy Policy 1 Zacks Investment Management reserves the right to amend the terms or rescind the free 2024 Year in Review offer at any time and for any reason at its discretion. 2 Zacks Investment Management reserves the right to amend the terms or rescind the free 2024 Year in Review offer at any time and for any reason at its discretion. DISCLOSURE Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. 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