Fed Set to Cut Interest Rates This Week. But Experts Say Next Year Brings Uncertainty

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After nearly two years of high interest rates, the Fed is widely expected to slash rates for the third time this year at Wednesday's Federal Open Market Committee meeting.

The Fed's monetary policy has a big impact on the economy, influencing the spending and borrowing patterns of US households and businesses. When the Fed raises its benchmark rate to tame inflation, the money supply decreases and the economy is supposed to slow. When the Fed lowers its benchmark rate, banks ease financial pressure on consumers, making it less expensive to borrow, from car loans to credit cards to mortgages.

A 0.25% interest rate reduction on Dec. 18 will have an effect on US households, yet the immediate impact is likely to be minimal. The federal funds rate held steady at a range of 5.25% to 5.5% for over a year, and a third rate cut will bring it down to a range of 4.25% to 4.5%.

Borrowing rates remain high going into 2025, and experts say this could be the last rate cut for a while. Financial markets are betting that the central bank will slow the pace of additional rate reductions next year or hold off on them entirely.

Why another rate cut at Wednesday's Fed meeting?

Since the Fed's role is to balance maximum employment and relative price stability, it heavily weighs the monthly Bureau of Labor Statistics jobs report and the Consumer Price Index report when deciding whether to raise or lower the federal funds rate, the rate used by banks to borrow and lend to one another overnight.

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Annual inflation is gradually improving, down to 2.7% from 9.1% in mid-2022. But price growth remains stubborn, and inflationary pressures are expected to increase with the next administration.

The labor market also plays a role. In September, with signals that the labor market was softening, the central bank started lowering rates to avert a recession. Today, unemployment is higher than last year's low (4.2% versus 3.4%), but the job market isn't collapsing.

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Following the release of recent labor and inflation data, market expectations shifted dramatically toward a 96% probability of a quarter-percentage-point rate cut, according to the CME FedWatch tool.

Many experts believe that since a third rate cut was already on the books this year, the economic outlook would've needed to shift more dramatically for the Fed to change its plans.

"[Fed Chair Jerome] Powell has led markets to believe the Fed will cut, and he won't want to disappoint the markets," said Robert Fry, chief economist at Robert Fry Economics.

Why fewer interest rate cuts in 2025?

Since progress regarding inflation has stalled, the Fed isn't likely to cut rates again until there are more consistent signs of cooling. September's Summary of Economic Projections predicted around four rate cuts throughout 2025, and the Fed will release new projections at its upcoming meeting.

"I now expect two rate cuts in 2025 versus the four I expected a few months ago," Fry said.

If the central bank lowers rates this week, Preston Caldwell, chief US economist at Morningstar, doesn't expect another cut right after President-elect Donald Trump's inauguration.

"If they do cut in December, there's a very high likelihood that they don't cut in January," said Caldwell. "If they were to hold off in December, then maybe they'll go ahead and cut in January."

Though the Fed might consider an interest rate reduction in March, monetary policy will continue to depend on future economic data. Inflation remains above the Fed's annual target goal of 2%, and Trump's economic agenda could change the Fed's strategy in 2025.

For example, Trump's pledge to impose tariffs on goods from several countries, including China and Mexico, would raise taxes on imported goods. Usually, businesses pass those costs down as higher consumer prices, which could reignite inflation.

But the outcome is yet to be seen. University of Central Florida economist Sean Snaith views tariffs as a negotiation tactic, part of a bargaining process between the US and its trading partners, not necessarily policies that will be pursued. "In the first Trump administration, we did see some tariffs enacted," said Snaith. "There were cries and fears that it would trigger inflation then, and that really didn't manifest itself."

Regardless of the Fed's decisions, if you plan to borrow money for a home or car, or have existing credit card debt, pay close attention to your annual percentage rate. Shop around for better rates before borrowing. If you have credit card debt, consider a balance transfer card with a 0% introductory period for relief from high APRs. And even if it eventually becomes less expensive to borrow in the long term, remember that lower interest rates also translate to diminished yields on savings accounts.