SFC Outlook 2025｜Paul Gruenwald’s Take on the Fed’s Rate Strategy and Market Risks

The World Economic Forum in Davos remains a key platform for global business and political leaders, drawing significant market attention. This year, discussions centered on artificial intelligence (AI) and the policy direction of the new U.S. administration, highlighting market sensitivity to technological innovation and economic policy uncertainties.

Meanwhile, on January 29, the Federal Reserve announced its decision to keep its benchmark interest rate unchanged, following three consecutive rate cuts in 2024. This reflects a more cautious stance as the Fed assesses inflation trends and potential economic policies under President Trump. The Fed emphasized that the job market remains strong, with unemployment staying low, while taking a firmer tone on inflation, stating it remains "somewhat elevated," suggesting limited room for further rate cuts.

In this edition of "Wall Street Frontline," Paul Gruenwald, Chief Economist at S&P Global, shares his insights on Fed policy and his observations from Davos. He provides an in-depth analysis of key market risks, global supply chain dynamics, U.S. bond market trends, and the Fed's policy outlook. He notes that while the pro-business stance of the new U.S. administration could support economic growth, uncertainties surrounding tariffs, immigration policies, and inflation remain major concerns for investors. Additionally, as global monetary policies diverge, a stronger U.S. dollar could pose challenges for external markets, particularly emerging economies reliant on dollar-denominated debt.

Looking ahead to 2025, Paul Gruenwald expects the Fed to maintain a cautious approach, with a possible rate cut in the first half of the year, though further easing will depend on evolving economic data. He also underscores the importance of scenario-based analysis amid rising market volatility, helping market participants navigate potential economic and financial shocks. 

Wall Street Frontline: Paul, you recently returned from Davos. Could you share your experience at the World Economic Forum? What were the most critical emerging topics this year?

Paul Gruenwald: There were two primary themes at this year’s Davos forum. The first, which was officially included in the agenda, was artificial intelligence (AI). There was significant enthusiasm surrounding AI and its potential to drive productivity gains, accelerate economic growth, and enhance corporate profitability.

The second key topic, which was not formally on the agenda, was the new U.S. administration. President Donald Trump made an online appearance, and there was widespread optimism regarding the outlook for the U.S. economy. These two topics dominated discussions at Davos this year.

Wall Street Frontline: What are the key economic risks that investors and stakeholders are most concerned about?

Paul Gruenwald: Let’s start with a potential upside risk. The new U.S. administration is expected to be pro-business, which could result in regulatory rollbacks, reforms in permitting processes, and overall improvements in the ease of doing business. This could provide an economic boost.

However, there are several downside risks to consider. The first is tariffs and the uncertainty surrounding trade policy. While tariffs may offer short-term economic boosts, historical evidence suggests they tend to hinder long-term growth and exacerbate inflationary pressures.

Another key risk is labor market dynamics, particularly related to immigration policy. Many foreign workers are employed in industries such as construction and agriculture. If restrictive immigration policies lead to a reduction in available labor, wages could rise, inflation could intensify, and economic output may decline. Additionally, inflationary pressures are already embedded in the economy, which presents an ongoing challenge for markets.

Wall Street Frontline: You just mentioned Trump's proposed economic policies, including deregulation, stricter immigration controls, and new tariffs, such as the recent announcement of a 25% tariff on imports from Mexico and Canada. How do you believe these policies, collectively, will impact both the U.S. domestic economy and the global economy?

Paul Gruenwald: The U.S. is a large and relatively closed economy, meaning trade accounts for a smaller share of GDP compared to other nations. As a result, the direct negative impact of tariffs on U.S. growth may be limited.

However, the more significant effects are likely to be seen in inflation and interest rates. The bond market has already priced in these expectations, with U.S. Treasury yields rising and the U.S. dollar strengthening. These financial shifts may not align with the administration's intended economic strategy. In the short term, the impact on financial markets may be more pronounced than the direct effects on economic activity.

Wall Street Frontline: How do you assess the impact of these policies on global supply chains?

Paul Gruenwald: Global supply chains are undergoing significant transformation. This shift is leading to the development of two distinct supply chain systems—one centered on China and another designed to bypass China. Businesses are increasing their inventory levels, implementing supply redundancies, and enhancing risk management strategies. While these measures improve supply chain resilience, they also increase operational costs, contributing to inflationary pressures globally.

Wall Street Frontline: What are your expectations for the U.S. bond market in 2025?

Paul Gruenwald: The bond market outlook varies across different maturities. At the short end of the curve, Federal Reserve policy remains the key driver. On Jan 30th, we adjusted our forecast following the release of fourth-quarter data and now anticipate only one rate cut from the Fed this year, followed by a pause. There is also a growing risk that the next move after that could be a rate hike rather than another cut, though this is not our baseline scenario.

For the long end of the curve, the 10-year Treasury yield has risen significantly, currently ranging between 4.5% and 4.6%. This has direct implications for mortgage rates and other long-term borrowing costs. Overall, we expect the yield curve to remain higher than previously projected, reflecting a structurally higher equilibrium interest rate. While this environment presents challenges for borrowers, it benefits savers.

Wall Street Frontline: Is the "higher for longer" rate environment still a reality?

Paul Gruenwald: Yes, the expectation of "higher for longer" remains intact, and rates may even trend slightly higher than previously anticipated.

Wall Street Frontline: On January 29, the Federal Reserve announced its decision to maintain interest rates. What was your initial reaction? Does this align with market expectations?

Paul Gruenwald: The Fed’s decision was widely anticipated. The U.S. economy continues to exhibit strength, with 2024 being another solid year of growth. Consumer spending, in particular, has outpaced overall GDP growth. Meanwhile, inflation—especially in the services sector—remains elevated above the 2% target.

Given these conditions, the Fed’s decision to pause and reassess is prudent. If the economy slows and inflation moderates, additional rate cuts may be considered. However, the new administration is expected to implement policies aimed at boosting economic activity, which could complicate the Fed’s decision-making process.

Wall Street Frontline: Given the latest economic data, including the quarterly PCE released on Jan 30th and monthly PCE on Jan 31st reading of approximately 2.6%, which aligns with market expectations, what does this indicate about the Federal Reserve’s confidence in the U.S. economy?

Paul Gruenwald: These figures reinforce the Fed’s assessment that the economy remains somewhat overheated. The PCE index is the Fed’s preferred inflation measure, making it a key indicator for policymakers. Chairman Powell has emphasized a data-dependent approach, maintaining a neutral stance without a clear bias toward rate hikes or cuts at this time. While markets have already priced in one additional rate cut, persistently high services inflation and elevated PCE levels serve as cautionary signals, suggesting that the Fed may take a more measured approach before considering further easing.

Wall Street Frontline: How might the Fed’s decision impact other central banks globally?

Paul Gruenwald: The impact depends on a country’s reliance on the U.S. dollar. For economies closely tied to the dollar, a prolonged period of higher U.S. interest rates may constrain their ability to ease monetary policy, as significant policy divergence could lead to currency volatility and capital outflows. Conversely, economies with greater monetary policy autonomy, such as the Eurozone and China, may have more flexibility in adjusting their interest rates.

Wall Street Frontline: You mentioned that S&P Global has forecasted only one rate cut for 2025. When do you anticipate it will occur?

Paul Gruenwald: Most likely sooner rather than later, likely within the first half of the year. There is a possibility that the Federal Reserve may delay its decision for a few meetings, but if economic conditions shift unexpectedly, it may lose the opportunity for further cuts. Our current expectation is for a rate cut around March or April, after which the Fed will likely pause to assess the broader economic trajectory. If the economy regains momentum, that single cut may be the extent of their easing cycle. However, much will depend on factors such as tariffs, labor market developments, and overall economic performance.

Wall Street Frontline: Inflation remains a key concern for many central banks. Do you believe it is still a significant challenge, or is it coming under control?

Paul Gruenwald: The inflation outlook is becoming clearer. The Eurozone reported stable inflation in the fourth quarter, and Canada appears to be on track for rate cuts. This suggests that while the U.S. may delay its easing cycle, other economies may move ahead with rate reductions.

If the U.S. maintains stronger economic growth and higher interest rates, it will likely support a stronger U.S. dollar. This could create challenges for foreign central banks, particularly those with significant exposure to dollar-denominated debt.

Wall Street Frontline: Considering the uncertainties surrounding Trump’s economic policies, how do you expect emerging markets to maintain resilience in 2025?

Paul Gruenwald: The resilience of emerging markets will depend on their economic structures. Larger economies with robust domestic markets—such as India, Brazil, Indonesia, and Saudi Arabia—are likely to navigate these challenges more effectively. However, smaller, trade-dependent economies with high levels of dollar-denominated debt may face increased difficulties, particularly if global trade conditions deteriorate or financial market volatility rises.

Wall Street Frontline: Are there any additional insights from S&P Global’s latest economic outlook that you would like to share?

Paul Gruenwald: Given the heightened volatility in global markets, we are placing greater emphasis on scenario-based analysis this year. Clients and stakeholders frequently inquire about the potential effects of increased tariffs on Mexico and Canada, or further trade restrictions on China.

Rather than making sweeping changes to our baseline forecasts, we are focusing on building flexibility into our research, analyzing various potential outcomes, and preparing for rapid shifts in the economic landscape. The coming year will require adaptability and readiness for a range of possible scenarios.