By Brian Johnson, Director of Investment Services

The Year In Review

As 2024 comes to an end, we’d like to take a moment to reflect on how certain economic and geopolitical events shaped the capital markets over the past year. Several key events took place over the past 12 months, including the Federal Reserve’s Federal Open Market Committee (FOMC) lowering their benchmark federal funds rate for the first time since the early stages of the Covid-19 pandemic and a federal election that will shift the makeup in Washington D.C. for the coming year, at least, if not the next two.

Over the course of 2024, the FOMC saw inflationary pressures continue to ease to go along with relatively strong employment numbers. As such, the FOMC reduced the federal funds rate by 50-basis points in September and by another 25-basis points at their meetings in November and December. As we turn the final pages on calendar year 2024, the federal funds rate will end the year at a target range of 4.25%-4.50%. This puts the benchmark overnight rate a full 100 basis-points lower than where it started the year, which was at its highest point in over 15 years.

Source: Federal Reserve Economic Data (FRED) as of 12/18/2024

Following the FOMC’s most recent meeting on December 18, Fed Chair Jerome Powell stated that “today was a closer call (on lowering the benchmark rate) but we decided it was the right call.” He also stated the FOMC can “be more cautious as they consider further adjustments to the policy rate” in the new year.

The FOMC continues to reiterate that they will remain data dependent in determining the timing and extent of its rate decisions. From an inflation perspective, the year-over-year reading for the Consumer Price Index (CPI) was up 2.7% (annualized) through November, while the Federal Reserve’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) deflator, came in at an annual increase of 2.8% through October. While we haven’t reached the Fed’s PCE target of 2% yet, the FOMC seems satisfied that inflation has ebbed sufficiently throughout 2024 to maintain their posture of easing monetary conditions by further reducing their benchmark rate.

The other focus area of the Fed’s dual mandate is maintaining full employment. The unemployment rate for November came in at 4.2%, up from 3.7% at the start of the year. Even with the unemployment rate ticking up over the course of the year, the economy added 227,000 jobs in November, outpacing market and economist expectations. By cutting the fed funds rate by 25-bps in December, the FOMC appears to be viewing the labor market as stable despite the uptick in unemployment over the past 12 months.

Throughout the entirety of the year, we saw meaningful fluctuations across the short and long end of the yield curve.  Despite those fluctuations, portfolio performance for governmental investors is on track to finish 2024 on a positive note (there are still a few trading days left, of course). While shorter duration portfolios have largely performed better than those with longer duration due to the aforementioned policy actions of the Federal Reserve, all benchmark U.S. Treasury returns through 5 years are set to end the year above 3% year-over-year growth from a total return perspective (coupon income and change in market value).

As we look ahead to 2025 and the five-year anniversary of the Covid-19 pandemic, our team is keeping an eye on several factors that could influence investment returns in the coming year. The Federal Reserve began its cutting cycle during the second half of 2024, lowering their benchmark rate by a full 1.00% since September. While inflation risks remain, we continue to monitor how the Fed will be approaching monetary policy in the new year with the goal of ”threading the needle” in terms of any monetary policy impacts to for the U.S. economy. Mixed into the forecast for 2025 will also be assessing the new landscape in Washington and the impacts policy changes might additionally have on the economy and fixed income market dynamics.

The CME’s FedWatch tool is currently pricing in a roughly 90% probability of the FOMC leaving rates unchanged at their meeting on January 29^th and about a 50/50 chance of no action or a 25-basis point cut at their next meeting in March. As a reminder, these are market expectations showing the likelihood of changes to the federal funds rate based on fed funds futures prices. There will be several economic data releases in advance of these meetings that will better inform the FOMC’s decisions (and those of investors). A new Congress and Presidential administration will also be sworn in with the turn of the calendar year.  We anticipate the FOMC will modestly continue their rate cutting cycle into 2025 which will affect re-investment rates on the short end of the market, but the timing and impact of those cuts remain to be seen.

As we continue to assess the policy and economic factors that might impact the interest rate environment and shape of the yield curve for the coming year, we also like to stress the benefit of building diversified bond portfolios that can weather various interest rate cycles. Ehlers remains a proponent of crafting  a long-term investment strategy to build cash flow stability and preservation of purchasing power for your entity’s operating needs in 2025 and years to come.

If you’re interested in discussing different portfolio strategies, please contact your Ehlers Investment Adviser to learn more.

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