- Continued economic strength along with inflationary policies expected from President-elect Donald Trump could mean the Federal Reserve may have to resort to rate hikes in 2025, a top economist warned.
Wall Street just threw a tantrum over indications that the Federal Reserve will make fewer rates cuts than expected next year, but a top economist has warned that a rate hike is possible too.
That's according to Apollo Global Management chief economist Torsten Sløk, who took a stab at calculating the odds of an increase.
"The strong economy, combined with the potential for lower taxes, higher tariffs, and restrictions on immigration, has increased the risk that the Fed will have to hike rates in 2025," he wrote in a note on Thursday. "We see a 40% probability that the Fed will raise interest rates in 2025."
In fact, the economy is so robust that the Commerce Department revised third-quarter growth higher this past week to 3.1%, up from an earlier estimate of 2.8% and the second quarter's 3% pace—meaning GDP accelerated a bit.
And estimates for the current quarter show no sign of a slowdown. The Atlanta Fed's GDPNow forecast points to another 3.1% print for fourth-quarter growth. Sløk noted that the latest estimate is well above the Congressional Budget Office's view for long-term growth of 2%.
Meanwhile, President-elect Donald Trump campaigned on tax cuts, higher tariffs, and an immigration crackdown, which are widely regarded as adding to inflationary pressures.
With inflation still stubbornly holding above the Fed's 2% target, those policies could give central bankers less room to lower rates further after cutting them by 100 basis points this year to 4.25%-4.50%.
In their economic projections for next year, Fed officials appeared to be taking those moves into account as they significantly raised inflation forecasts without similar changes to economic growth and unemployment estimates.
"For investors, it is starting to look similar to 2022—too high inflation, rising interest rates, and falling stock prices," Sløk added.
In 2022, the S&P 500 sank 19% and the Nasdaq tumbled 33%, as markets suffered their worst year since 2008.
Others on Wall Street are also seeing more hawkishness from the Fed next year. Market veteran Ed Yardeni said in a note Wednesday that the odds of just one or even no rate cuts next year are higher.
That's as the so-called neutral rate—the level that neither speeds up nor slows down growth—remains uncertain as analysts assess whether the economy can now withstand tighter monetary policy than before.
"We think that economic growth will be much stronger than the Fed expects and therefore that the neutral rate is higher than 3.0%, perhaps closer to 4.5%–5.0%," the Yardeni Research note said. "If real GDP growth beats the Fed's expectations, as we expect, then the FOMC may be on pause for a while."
