2024-2025: How interest rate decisions will reshape your investment portfolio

The Current Landscape of Interest Rates and Its Implications for Investors

Interest rates are at their highest levels not seen in a decade and a half. The United States maintains its federal funds rate at 5.50%, while in the European Union the benchmark rate reaches 4.50%. This situation has radically transformed access to credit and the performance of different asset classes. The current scenario is particularly interesting because markets are already pricing in future rate cuts, creating opportunities for both conservative investors and speculators.

What is the background of this landscape? The last four years have been turbulent: a global pandemic froze economies, governments responded with massive fiscal stimuli, supply chain disruptions erupted, commodity prices rose, and geopolitical conflicts amplified inflationary pressures. The result was widespread inflation reaching 9.1% in the United States (June 2022), 10.6% in the European Union (October 2022), and 11.1% in the United Kingdom during the same period. Central banks responded with aggressive rate hikes to “cool down” demand.

How Far Has the Deflation Gone? The Current State of Inflation

Central banks aim for an inflation target close to 2% annually. Looking at core inflation (excluding food and energy), progress has been uneven across regions:

• United States: Core inflation of 3.8%, nearly double the target. Although it has decreased from peaks, resistance to further decline persists.
• European Union: 2.9%, much closer to the desired level, facilitating possible monetary easing.
• United Kingdom: 4.2%, still requiring additional containment efforts.
• Japan: 2.6%, though concerns focus on how policy changes impact the yen.

This differentiated performance across regions is crucial: it suggests that monetary policies will not move in unison, opening doors to divergences that benefit certain assets like currencies and fixed income.

Economic Growth and Employment: The Other Side of the Coin

Beyond inflation, central banks monitor GDP growth and unemployment to prevent high rates from triggering a recession.

In the United States, annualized GDP grew 4.9% (Q4 2023), 3.4% (Q1 2024), and 1.6% (Q2 2024), showing deceleration but maintaining momentum. Unemployment remains low at 4.0%, signaling a relatively robust economy. This suggests that the FED is not in a hurry to cut rates if inflation does not fully subside.

In the European Union and the United Kingdom, the scenario is different. Both regions have experienced a sharp slowdown since mid-2022. The EU registered zero growth in Q3 and Q4 of 2023. This relative weakness makes it easier for their central banks to start cutting rates before the US, potentially stimulating economic recoveries without reigniting inflation.

In Japan, the unemployment rate remains under control, but authorities focus more on managing the yield curve than on further rate hikes.

Interest Rate Forecasts for 2024: Expectations by Institution

FED (United States)

The Federal Reserve mainly depends on inflation data. Spikes observed in December 2023 and March 2024 delayed expectations of cuts. The IMF estimates that the federal funds rate could reach a maximum average of 5.40% before gradual decreases. In its March projections, the FED estimated a median of 4.60% for December, with a range of 3.90%-5.40%. Optimistic scenarios point to a peak of 5.25% in Q2 2024, followed by a gradual decline to 3.75% by year-end if inflation resumes its downward trend.

European Central Bank

Recent concerns about inflation could keep rates elevated longer than expected. Some analysts project a decrease to 4.25% in H2 2024, although markets anticipate more substantial reductions. Eurobor futures at 3 months suggest a decline from 4.00% to 3.2% by year-end and 2.6% by the end of 2025. A possible first cut in Q3 2024 does not rule out an initial small reduction of just 25 basis points.

Bank of England

In May 2024, rates were maintained at 5.25%, but 2 out of 9 members voted for a cut, indicating a possible shift toward easing. Market expectations predict holding rates until summer followed by gradual reductions to 4.75% by year-end. The NIESR forecasts only 2 cuts of 0.25% in 2024, citing persistent inflation and rising wages.

Bank of Japan

In March 2024, it increased its target rate to 0.10%, a historic change after years of negative rates. However, it emphasized a cautious approach and commitment to loose monetary policy. Further adjustments are expected to be limited, with yield curve management possibly taking priority over additional hikes.

Likely Timeline for the First Rate Cuts

According to May 2024 projections, the first cuts could occur:

• Q2 2024 (before June) in the United States and European Union
• Q3 2024 (before September) in the United Kingdom
• Q4 2024 (before December) in Japan, though potentially upward

This staggered approach precisely creates opportunities in currency markets.

Interest Rate Forecasts for 2025: A Year of Significant Adjustments

Assuming inflation trajectories remain stable, 2025 will see multiple rate cuts:

• FED: Estimated median of 3.60% for December, with a range of 2.40%-5.40%
• ECB: Close to an annual average of 3.3%, decreasing from 4.50% at the start of the year to 2.00% in November-December
• Bank of England: Expected stabilization in the range of 3.00%-3.40%
• Bank of Japan: More uncertain behavior, dependent on yen performance

Assets and Sectors to Seek for Returns

Forex Market: Divergences in monetary policies will generate attractive movements. The EURUSD pair will appreciate if the ECB cuts before the FED. The GBPUSD will follow a similar pattern. The USDJPY has already risen 5.3% since March 2024 after the Bank of Japan’s hike, demonstrating how policy shifts move currencies dramatically.

Fixed Income: Substantial capital gains will occur when rates decline steadily. Even without this, government and corporate bonds will generate valuable recurring flows in an environment of high inflation.

Real Estate and REITs: The real estate sector, battered by high borrowing costs, could recover with rate cuts. REITs offer passive exposure through attractive dividends.

Technology: Tech stocks could continue advancing in the short term but with higher risk. Large-cap cryptocurrencies (Bitcoin, Ethereum) correlated with tech could also benefit from cuts in 2024.

Major Indices: S&P 500, Dow Jones 30, and NASDAQ 100 are trading at all-time highs. Despite high rates, markets are discounting cuts this year, supporting the rally.

Risks Threatening Interest Rate Forecasts

Resurgence of inflation: The forecasted cuts rely almost entirely on inflation continuing to decline. If it resurges, markets will abandon bullish expectations and severe corrections may occur.

Always the unexpected: Obvious investment narratives often fail. In 2022, “experts” predicted a recession that did not materialize. Now, the US presidential elections in November could exert political pressure on the FED.

Decades-long cycles: Historically, between 1940-1980 rates rose; between 1980-2020 they fell. Assuming central banks will return to near-zero rates without limits is counterintuitive. Long-term cycles suggest rates could stay elevated longer than expected.

Geopolitical surprises: Unexpected conflicts could reignite supply pressures, complicating the inflation scenario.

Final Recommendation: Flexibility in Any Scenario

Do not adhere to a single narrative. Whatever the evolution of interest rates, opportunities will be available for those who know how to identify them. Both rate cuts and sustained high rates create opportunities across different assets. The smart investor diversifies, regularly monitors economic data, and adjusts exposure based on how macroeconomic realities actually evolve, not based on predictions.