Investing.com — The Federal Reserve will cut the federal funds rate by 25 basis points in 2025 due to labor market weaknesses, and will deliver no additional cuts in 2026 or 2027, Wells Fargo (NYSE:) Investment Institute said in a report.
The investment bank believes that the potential for higher economic growth and the risk of reaccelerating inflation will limit further policy easing, leading to the federal funds rate ending 2027 within the 4.00%-4.25% range.
“Following those expectations, we expect higher 10- and 30-year Treasury yields by the end of the three-year cyclical outlook and for the yield curve to steepen as is typical during the expected period of economic growth,” the report states.
Wells Fargo highlights that U.S. economic growth remained robust in the third quarter of 2024, with an annualized quarter-over-quarter GDP growth of 3.1%, marginally higher than the previous quarter’s 3.0%.
The firm expects a mild economic slowdown in early 2025, followed by a moderate global growth recovery, with growth returning to its long-term potential rate by 2027.
Inflation is expected to rise early but remain limited, with the Consumer Price Index (CPI) 12-month growth forecasted to increase from November’s 2.7% to 3.3% by December 2025, before easing slightly. This rate would be above the sub-2% level seen in the pre-pandemic decade but in line with the 20-year average before that.
The core Personal Expenditures (PCE), the Fed’s preferred inflation gauge, showed a 2.8% increase for November over the last 12 months.
Meanwhile, the U.S. labor market has shown signs of softening, with the unemployment rate at 4.2% in November. Wells Fargo predicts a peak unemployment rate of under 5% during mid-2025, which will be followed by job growth in line with moderate economic expansion.
In terms of investment strategy, Wells Fargo expects front-loaded equity returns, particularly strong in 2025, due to anticipated earnings growth and pro-growth policies. However, the lack of a recessionary environment may affect performance in 2026 and 2027 as interest rates are expected to stay elevated.
“We remain tilted toward high-quality assets and believe investors should continue to favor U.S. Large-Cap Equities over Mid Cap and Small Cap,” Wells Fargo said.
This preference for quality also applies to international markets, where the bank favors developed market equities outside the U.S. over emerging markets. Ongoing geopolitical and regulatory risks, coupled with slower growth prospects in China, lead Wells Fargo to maintain a cautious stance on emerging markets for the time being.
