Will the Federal Reserve raise or lower interest rates?
This seemingly distant question actually impacts everyone's wallet. It's 2025, and US inflation hasn't completely subsided. The core PCE (Personal Consumption Expenditures Price Index) rose 3.0% year-on-year in January, far exceeding the target of 2%. Some say the rate hike is too drastic and the economy can't handle it; others wonder, what will happen if there's no rate hike? Financial markets are buzzing with activity, as investors watch the Fed's moves and struggle to decide between the stock and bond markets.
The Fed's Dilemma:
Inflation, Employment, and Political Gambling
- The Fed's interest rate decisions have always been seen as a bellwether for the global economy, but this time, its unwavering inaction has surprised the market. On the surface, the Fed's reasoning is sound: inflation remains untamed. Although the US core inflation rate has fallen from its 2024 peak, the Consumer Price Index (CPI) still reached 2.9% year-on-year as of April 2025, exceeding the policy target of 2%. To complicate matters further, the tariffs implemented by the new US administration are adding fuel to the fire. From steel to daily necessities, these tariffs are being passed down through the supply chain, further pushing up prices.
- Meanwhile, the resilience of the labor market presents the Federal Reserve with a dilemma. In December 2024, US nonfarm payrolls surged by 256,000, the unemployment rate fell to 4.1%, and hourly wages rose by 3.9% year-on-year. These data should indicate a strong economy, but they conceal a contradiction: corporate profits are being squeezed by rising wages, consumer confidence remains low, and business investment intentions are subdued. Federal Reserve Chairman Powell has bluntly stated that cutting interest rates at this time could "undo previous anti-inflation efforts" and even cause market expectations to spiral out of control.
- Even more subtle is the political pressure. Since Trump returned to the White House in January 2025, his economic policies have repeatedly conflicted with the Federal Reserve's independence. While pushing for policies that could exacerbate inflation, such as tariffs and immigrant deportations, Trump has openly pressured the Fed to cut interest rates, even threatening to remove Powell. However, the Fed clearly refuses to be seen as a "political tool." Powell explicitly stated at the press conference, "We don't need to rush into action." This statement was both a response to the White House and an effort to maintain the central bank's credibility.
Economic Impact
- Changes in Loan Product Costs
The Fed's interest rate cuts will directly affect the interest rates on loan products, thereby changing the financing costs for businesses and individuals.
Business and Personal Loans: Interest rate cuts typically lead to lower loan interest rates, reducing the debt burden of businesses and individuals and stimulating investment and consumption.
Mortgage Loans: Fed rate cuts are likely to lower mortgage rates, increase home purchase demand, and thus have a positive impact on the real estate market.
Auto Loans and Other Consumer Loans: Rate cuts will also reduce the cost of these loans, potentially boosting sales of cars and other durable goods.
- Currency, Bond, and Stock Values
The Fed's interest rate cuts have a significant impact on various asset prices in the financial markets.
Money Market: Rate cuts typically reduce the yields of money market funds, as these funds invest in short-term bonds and other highly liquid assets.
Bond Market: Rate cuts increase the prices of existing bonds, as the lower interest rates on newly issued bonds make existing bonds relatively more attractive. Long-term bonds benefit particularly because their interest rates fall more significantly.
Stock Market: Interest rate cuts typically boost corporate earnings expectations due to lower financing costs and increase the relative attractiveness of stocks, as they offer higher return potential than bonds.
- Global Economic Impact
The Fed's interest rate cuts not only affect the US economy but also have spillover effects on the global economy.
Emerging Markets: A Fed rate cut may trigger capital inflows into emerging markets as investors seek higher returns. This could increase the value of emerging market currencies and asset prices.
Global Trade: A weaker dollar may improve the competitiveness of US exports, but it may also increase import costs, impacting global trade patterns.
Global Monetary Policy: A Fed rate cut may prompt other central banks to follow suit to prevent their currencies from appreciating excessively against the US dollar, which could affect export competitiveness.
Financial Market Impact
- Stock Market Reaction
A Fed rate cut typically has a positive impact on the stock market because lower interest rates reduce corporate borrowing costs, increase consumer and business purchasing power, and thus stimulate economic growth. According to historical data, the US stock market saw a short-term rally after the Federal Reserve announced a 50 basis point interest rate cut on September 18, 2024. However, the market reaction is not uniform, as investors also consider the economic outlook and potential risks behind the rate cut. For example, if the rate cut is due to slowing economic growth or increased uncertainty, the market may be concerned about future earnings, which could limit the stock market's upside.
- Bond Market Dynamics
The Fed's rate cuts also have a significant impact on the bond market. Generally speaking, falling interest rates lead to rising prices for existing bonds, as they become more attractive relative to newly issued, lower-interest-rate bonds. Following the Fed's rate cut in 2024, US Treasury yields generally fell, indicating market expectations of continued lower interest rates. Furthermore, rate cuts can affect the shape of the bond yield curve. For example, a decline in short-term interest rates could make the curve steeper or flatter, depending on market expectations of the future economic outlook.
- Foreign Exchange Market Fluctuations
The Fed's rate cuts are also significant for the foreign exchange market. Rate cuts typically reduce demand for US dollar assets as investors seek higher-yielding currencies. Following the Federal Reserve's interest rate cut in 2024, the US dollar index declined, reflecting a market reassessment of the dollar's future value. Meanwhile, the appreciation of other currencies relative to the dollar may increase the competitiveness of US exports, but it may also impact import prices. Foreign exchange market volatility is likely to increase as investors assess the impact of the global economic environment and monetary policy changes on currency values.
The Fed's three instances of "not cutting interest rates" not only epitomize the internal economic contradictions of the United States but also illustrate the policy game in the era of globalization. From Washington's tariffs to Beijing's policy toolkit, from Wall Street's capital flows to Shenzhen's factory orders, every decision is reshaping the global economic landscape. In this game, there are no absolute winners, only survivors who constantly adapt.