If you’re anything like my better half, you spent much of this past holiday season trying to stay warm… yes apparently that’s necessary even in Florida if you can believe it… while out on the golf course. Regulating her internal body temperature often became of primary importance and required the addition and removal of multiple jackets and blankets as she aimed to find that perfect balance (not too hot and not too cold), amid constantly changing temperatures throughout the days spent in the shade and the sun.

The Fed has similarly been trying to find that perfect balance, albeit on a slightly larger scale, as it tries to prevent a possible recession and retain strong economic growth without overheating the economy. These Fed decisions will continue to be front and center as we enter 2025, and we’ll also take a quick look back at the layers the Fed has chosen to take off over the past few months.

Economic Overview

The economic outlook for 2025 has shifted somewhat, with inflation expected to be higher than previously anticipated. The Fed projection for Core PCE in 2025 was revised up to 2.5% from 2.1% in September. Remember, the Fed’s goal for inflation is typically 2%. This adjustment comes in part due to President-elect Trump's plans to enact broad-based tariffs on imports, which could drive up costs across various sectors, further fueling inflation. This reduces the likelihood of interest rate cuts, as while inflation remains elevated, the central bank may be more cautious in loosening monetary policy, potentially leading to sustained higher rates in an effort to control inflationary pressures and prevent the economy from overheating. In fact, this was indicated during the last FOMC meeting, as the Fed is now penciling in only two rate cuts in 2025, down from the four it had forecast in September when it last issued economic projections.

Interest Rates: Short Term vs. Long Term

The common misconception that we find when speaking with groups is the anticipation that the fed cutting rates will immediately result in a reduction in the cost of long-term borrowing. If the Fed cuts 25-basis points, it’s easy to think that all rates should follow suit.

However, the reality is short-term rates, like SOFR, are directly correlated and influenced by Fed policy, while long-term rates move based on future market expectations, and these past few months have been a stark reminder of this reality. To put it into context, the cost of floating rates has reduced by 1% since September, yet the 10Y treasury has increased by roughly 0.77% during that same time frame.

This increase in the cost of long-term borrowing can be explained by the market already pricing in less anticipated cuts in 2025 and beyond, in turn pulling these long-term rates back up. The market will continue to price in these expectations, reacting to changes in Fed commentary and the latest economic reports. So, for those borrowers that are subsequently cautious about locking in long-term rates, it’s worth recognizing that any planned cuts are already baked in, and by waiting you are essentially betting against market expectations.

That being said, for those that are willing to gamble and take on that floating rate risk, it could be possible to find solace in relatively recent historical data that demonstrates that the market commonly underestimates the pace and magnitude of rates cuts during these easing cycles.

There isn’t necessarily a right or wrong answer of whether to fix or float, but it’s always important to know what you’re really betting on.

Read the Q4 Interest Rate Analysis.