Introduction

After raising the fed funds rate an unprecedented 11 times between March 2022 and July 2023 to the highest level in over 20 years at 5.25 – 5.50%, the Federal Reserve retained a policy sentiment of “higher for longer” for most of 2024.

The effort to curtail inflation finally eased in September 2024 when the Fed made its first rate cut in over a year. By the end of the year, the fed funds rate had been reduced 100 basis points, bringing the range to 4.25-4.50%.

The following synopsis captures a chronological review of this year’s pivotal capital market themes and will also provide an assessment of where markets are positioned going into the new year.

Markets expect cuts while Fed remains cautious

In early 2024, a clear divide emerged between the Federal Reserve’s cautious approach and market expectations for aggressive rate cuts. While the Fed held rates steady at the January 2024 FOMC meeting, futures trading data suggested that the markets anticipated up to six rate cuts for the year. This ongoing uncertainty over inflation and monetary policy direction would continue over the coming months.

Early market woes

The first quarter saw challenging economic news for fixed-income markets, with persistent inflation and rising delinquency concerns in regional banks like New York Community Bank. By mid-February 2024, investors tempered their rate-cut optimism to expecting only three to four quarter-point rate cuts by year-end. Agency CMBS trading activity faced challenges as interest rates rose, and Fannie Mae DUS/MBS weekly rate lock volumes averaged their lowest levels since 2020.

Jobs and inflation impact investment strategies

An unexpectedly strong Nonfarm Payrolls report released in early April 2024 showed the largest job gains in over a year. Paired with reports of the hottest annualized Consumer Price Index inflation of the year and robust retail sales data, the 10-year Treasury yield hit 4.70% by late April. Investors were forced to rethink their investment strategies and adjusted expectations to only one to two quarter-point cuts quarter-point cuts for the remainder of the year.

Political tensions stir markets

By mid-year 2024, the Fed’s Summary of Economic Projections report emphasized that inflation had eased, though it remained too high. However, Fed officials began hinting that a cut could be in sight. Inflationary concerns and pricing pressures dominated the competitive U.S. presidential race, driving expectations of an expansionary fiscal policy. This led to the rise of “term premium,” which captures the difference in yields between short-term and long-term fixed-income securities, as the election race continued.

Fed makes dramatic rate cut

By early August 2024, reports indicated a cooling labor market and diminishing upside inflation risks, making a rate cut at the September 17-18 FOMC meeting imminent. In anticipation, the 10-year Treasury yield hit a year-to-date low the day before the meeting. To support a softening labor market, theFed cut rates by 50 basis points, higher than the usual 25-basis-point increment. This decision received the first dissenting vote from a Fed Governor since 2005, with Michelle Bowman citing lingering inflationary risks.

Red sweep and Fed rate cuts

Entering the fourth quarter of 2024, the market focus remained on the election while uncertainty regarding fiscal policy drove yields higher through October. The unexpected “Red Sweep” in November led to a resurgence in the term premium, as markets anticipated potential fiscal expansion. The Fed cut rates by 25 basis points consecutively in both its November and December meetings, while Chairman Jerome Powell attributed the rise in yields to stronger growth expectations rather than economic risks.

A hawkish transition into a new phase

Labor market concerns that led to the initial September 2024 cut appear to have stabilized. The Fed’s latest projections indicate only two quarter-point cuts in 2025, more hawkish than expected. Policymakers have implied a “slower to lower” strategy in order to achieve inflationary progress. The yield curve renewed its steepening trend and ended 2024 at a year-to-date high while 10-year Treasury yields surged. Fannie Mae DUS rate lock volumes also spiked in Q4, driven by tightening credit spreads.

Looking ahead

Slower-to-lower

Despite the last FOMC Meeting concluding 2024 on a hawkish “slower-to-lower” tone, the market anticipates additional cuts this year. Consensus aligns on projections for the federal funds rate to fall to a range of approximately 3.75% by the end of 2025. This is facilitating the potential for more favorable conditions for fixed-income products, specifically in the commercial mortgage-backed securities (CMBS) financing market.

Key trends anticipated in the year ahead

Fed’s dual mandate:
Balanced job growth, headline annualized PCE inflation near 2.2%, and two rate cuts expected.

U.S. economic growth:
Slower growth, resilient consumer activity, GDP ~2%.

Fiscal policy:
Potential shifts in tax and budget policies under Republican control.

CMBS investor appetite:
Renewed demand as banks reenter and Basel III rules adjust bank capital requirements.

Rates outlook

Bloomberg’s 12/17/24 survey suggests Treasury yields will decline in 2025, with the 10-year yield forecasted at 4.25% in Q1 and 4.15% by year-end. Inflation has dropped significantly since 2022, though it remains above the Fed’s 2% target. Although the path towards the Fed’s inflation target has been characterized as “sometimes bumpy,” markets today anticipate that the FOMC will be justified in normalized policy rates lower as economic data gradually vindicates the Fed’s decision-making.