Projected US interest rates in 5 years: Third party round up

By Daniela Hathorn10:09 (UTC), 13 December 2024 Updated

Financial data on the monitor — Can the US Fed hold off its planned interest rate rises? Photo: foxaon1987 / Shutterstock.com

The U.S. Federal Reserve cut interest rates for the first time in over four years on September 18, 2024, reducing the federal funds rate by 50 basis points, bringing it down to a range of 4.75% to 5%. This marked a shift from the Fed's aggressive rate-hiking cycle, which peaked at 5.25% to 5.5% earlier in the year. The decision was influenced by easing inflation and signs of a weakening labor market. It also reflects the Fed's aim to support economic growth without triggering a recession, signaling more potential rate cuts in the coming months. The decision was followed by another rate cut, this time 25bps, on November 7th.

As the US central bank starts its cutting cycle, what are the projected interest rates in 5 years?

Projected interest rates in 5 years

Interest rate projections typically focus on the short-term as longer-term rates are harder to predict. By the end of 2025, the U.S. Federal Reserve's interest rate is projected to range between 4.0% and 3.5%, based on several forecasts.

ING and J.P.Morgan expect the Fed to lower rates by 25 basis points each quarter in 2025, potentially leaving rates slightly higher at a range of 3.5% to 3.75%, as the central bank shifts from restrictive policies to a more neutral stance.

Similarly, Morgan Stanley expects a gradual reduction to rates in 2025 as the economy shows resilience and an expected “soft-landing”, suggesting the terminal rate for the year could be around 3.5%.

Meanwhile, Bank of America expects the Federal Reserve to cut interest rates by 25 basis points at its March and June meetings and then pause, potentially leaving the terminal rate higher at a range between 3.75% and 4%.

The exact path will depend on inflation trends, employment conditions, and overall economic performance.

For the longer term, if inflation trends remain favorable and economic activity stabilizes, the Fed might reduce rates further. Projections suggest the rate could normalize to between 2.5% and 3% under a gradual decline scenario. However, persistent inflation or an economic slowdown could alter this trajectory significantly.

Note that the analysts’ interest rate predictions for the next 5 years can be wrong. Interest rate forecasts shouldn’t be used as a substitute for your own research. Always conduct your own due diligence. And never invest or trade money you cannot afford to lose.

Will interest rates continue to go down?

As the forecasts above reflect, interest rates are expected to be reduced gradually over the coming months. The speed and size of the cuts will depend on how the economy progresses. If the “soft landing” is achieved and the US economy shows stable growth and employment, then the US Federal Reserve will see less need to cut rates aggressively, leading to a higher terminal rate. It is also important to note that Trump’s protectionist measures could lead to higher inflation in the US, which could also limit the Fed’s ability to cut rates in the next few years. Alternatively, if economic data starts to worsen and the Fed becomes concerned with the stability of the economy, then they could cut rates more aggressively in an attempt to spur growth.

Interest rates and their role in financial markets

Interest rates forecasts have huge ramifications for the wider economy, with decisions by the Fed moving markets across equities, bonds and commodities.

The Fed sets the Federal Funds Rate (FFR), the key base interest rate that filters through to banks, affects demand for bonds and more broadly the economy and stocks.

The process starts when the Fed sets the FFR at the Federal Open Market Committee (FOMC) meeting, eight of which occur every year. Those decisions, which resulted in numerous hikes in 2022, filter through to prime rate, the basic interest rate banks charge to credit-worthy customers.

A hike to the FFR will see the base prime rate rise, affecting the typical cost of loans and mortgages. Increasing the cost of servicing loans takes more discretionary income out of consumers and businesses, dampening demand and reigning in price increases.

For stocks, that could mean companies and stocks dependent on consumer spending, like the retail and hospitality sectors, face headwinds. Growth stocks, which rely on lending and capital, could also suffer as investors look for value in profitable companies to ride out market volatility and a downturn.

Mechanically, interest rate rises also hit the value of bonds. When interest rates rise, the yield on a bond becomes less valuable, as it garners less interest than the prevailing base rate, forcing a sell-off. This is particularly true for longer-term interest rates, as the discrepancy is magnified over time.

Likewise, fixed-income securities lose their value with rises as the cost of not owning other interest-rate tracking assets increases. Indeed, it means the predicted interest rates in the next 5 years could be one of the most telling indicators for markets.

History of the Fed’s interest rate policy

Like other major Western economies, the US has enjoyed an unparalleled period of low price and interest rate volatility. The FFR was at a pretty low rate of under 2% in the 1950s, amid the postwar stimulus and income growth across the US. The rate see-sawed over a 20 year period, rising and falling between 3% and 10% during the 1960s and 1970s, before skyrocketing inflation that exceeded 13% in 1980 forced rates to a record high of 19.1%.

As inflation was brought under control, the FFR hovered around 5% through the 90s, before recessions in 2001 and 2008 forced them down to a floor, keeping rates down until 2016.

The Covid-19 pandemic imposed another cut to almost 0%, with recent inflationary pressures forcing the Fed to begin tightening policy. The Fed increased rates seven times in 2022, and four times in 2023, with the federal funds rate reaching a range of 5.25% to 5.5%, marking its peak during this cycle.

Key factors that could influence interest rates in five years

Key factors that could influence interest rates in five years include:

Inflation Trends: Persistent inflation may lead to higher rates for longer, while controlled inflation could allow for further rate cuts.
Economic Growth: A strong economy will remove the need for the Fed to cut rates more aggressively, while stagnation or recession could prompt quicker and larger cuts.
Labor Market Conditions: Wage growth and unemployment levels are key considerations for central banks when deciding monetary policy as they can directly influence inflation and growth.
Global Economic Events: Geopolitical shifts, supply chain dynamics, and international monetary policies could impact domestic rates.
Fiscal Policy: Government spending, debt levels, and tax policies play a role in shaping monetary strategies. The effects of Trump’s tariff policies will likely impact the Fed’s ability to cut rates in 2025.

Past performance is not a reliable indicator of future results.

FAQ

How often do interest rates change?

The Federal Open Market Committee (FOMC) meets eight times a year to set interest rates. Rates change less frequently than this, most often during times of economic upheaval.

Where will interest rates be in 5 years?

Several rate forecasts at the end of 2024 see interest rates in the US dropping to a range between 4% and 3.5% in 2025 as the US economy remains stable. The central bank will want to gradually reduce the base rate as policy has been restrictive for a long time, but it will be careful to not act too quickly, leading to a renewed uptick in inflation. For the longer term, the base rate is likely to drop to a normalised level, likely between 3% and 2.5%.

You should do your own research to come up with an informed view of the stock. Remember that past performance is no guarantee of future success. And never invest money you cannot afford to lose.

Will interest rates go up or down?

This will depend on a number of factors such as whether inflation eases and the health of the economy. Policymakers may look into economic indicators such as consumer price index (CPI), gross domestic products (GDP) and other benchmarks when deciding on monetary policy.