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Don’t fight the Fed.
Most investors are familiar with that well-worn mantra, which cautions against making investment decisions that go against whatever policy the Federal Reserve is currently pursuing, whether that is loosening financial conditions to stimulate economic activity or tightening them to put a brake on it.
And historically that noncombative advice has been wise – as the Fed is enormously powerful, both domestically and internationally. It has access to effective tools and essentially unlimited funds to pursue its objectives (the Fed can create money with a mere keystroke – no actual printing of currency is necessary).
That means that it’s unwise to be too bullish when the Fed is hiking its target interest rate… or too bearish when the Fed is cutting that rate.
Right now, however, investors might consider forgetting about the Fed for a bit.
Why?
First, it looks very possible that the Fed is on hold for the foreseeable future.
The Fed Funds Futures market now sees just one quarter-point cut this year, and not until the second half.
(Its target rate is currently in a range of 4.25% to 4.5%.)
Here are the futures market probabilities for that rate at the end of 2025….
You can see that futures traders see a 40.5% chance the Fed will cut its target rate just once by the end of the year, and about a 29% chance it won’t cut at all.
Part of the reasoning behind this has to do with the stickiness of inflation. Yes, it has come down significantly from more than 9% in mid-2022… but it now remains stuck around 2.7%, which is still high compared to the Fed’s 2% target level.
Also, last week’s blowout employment report – which showed the economy created a whopping 256,000 new jobs in December – indicates the economy is still running hot and is not in need of any type of stimulus.
Just as important, Federal Reserve Chairman Jerome Powell sounded decidedly hawkish – that is, against more monetary easing – in his December press conference, saying the central bank would be “cautious about further cuts” this year.
Ineffective Policy
The Fed began cutting its target interest rate in September of 2024 and has brought that rate down one percentage point since then.
Oddly, however, that monetary easing has been relatively ineffective in easing borrowing costs in the economy.
Consider the 30-year fixed mortgage rate. It’s been rising since the Fed started cutting and now stands at a six-month high of nearly 7%…
How is that possible?
Well, remember that the Fed controls an interest rate at the extreme short end of the borrowing curve. In fact, the federal funds rate is the rate at which commercial banks borrow and lend to each other overnight.
So it doesn’t directly control longer-term rates that people and businesses generally use to borrow and lend money – like bank loans, car loans, and mortgages. Sure, the Fed sets the direction and tone for those longer-term rates, but they don’t always follow in lockstep with the overnight lending rate.
And lately bond traders have been much more influential in the direction of longer-term rates.
Believing that Presiden-elect Trump’s tariff policies might reignite inflation, and that federal government borrowing is out of control, those traders have pushed the 10-year Treasury yield up to around 4.8%. Mortgages and other longer-term rates tend to follow that benchmark borrowing rate.
So, instead of reverting to the “good news is bad news” strategy – which pushes investors to sell on good news (like the recent jobs report) because it will discourage the Fed from cutting rates – wiser investors might forget about the Fed for the moment and focus on the economy and, more important, company fundamentals and corporate earnings.