Growth Moderating, Higher Interest Rates Expected, St. Louis Fed Economist Says

Re-Published With Permission From Construction News and Review

By Kerry Smith Buck | Image Courtesy Federal Reserve Bank of St. Louis

Federal Reserve Bank of St. Louis Economist & Research Officer Charles Gascon told an audience of Associated General Contractors of Missouri members January 14 that the markets expect higher interest rates as compared to a few months ago.

Gascon spoke at the AGCMO’s annual Look-Ahead Lunch in St. Louis. More than 60 construction industry professionals learned from Gascon that the 2025 economic outlook includes an expected path of the federal funds rate – the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight – that is anticipated to decrease slightly and then flatten over the next 24 months.

Fixed income markets, Gascon said, anticipate that the Federal Reserve will cut interest rates in 2025, but not by much. Short-term interest rates are expected to end 2025 close to four percent. That’s down from the current 4.25 percent range to 4.5 percent as of January 2025, and it’s after the Fed cut rates in December 2024.

Some economists anticipate that by the end of 2026, the policy rate – the target federal funds rate set by the Federal Open Market Committee (FOMC) – will be another 50 basis points lower, at 3.4 percent. The FOMC is comprised of 12 individuals – seven members of the Federal Reserve System’s Board of Governors, the president of the Federal Reserve Bank of New York and four of the remaining 11 Reserve Bank presidents.

“Our contacts tell us that the economic outlook is tepid but improving,” said Gascon. “They expect the outlook to improve over the next six to twelve months. There’s a steady upward movement.”

Real GDP growth – growth that measures the monetary value of final goods and services, such as the cost of construction projects – is projected to moderate from an estimated 2.3 percent in 2024 to 1.9 percent in 2025 amid higher unemployment. Economists are then anticipating GDP growth to average1.8 percent from 2026 to 2035.

What does this mean to the construction industry? General contractors, subcontractors and suppliers – as well as project owners – can expect higher price tags.

“The past couple of months, we’ve begun to see an uptick in inflation expectations,” Gascon said. “There’s definitely a higher degree of uncertainty in the outlook for economic growth.”

Gascon adds that he is hearing that a lot of private equity firms are positive about the near-term economic outlook, but that the cost of capital is a lot higher than they expected it to be. “While the number of (construction project) leads coming in are good, they say, the number of projects actually penciling out are fewer.”

With regard to the inflation scenario, it depends upon the bystander’s point of view – whether he’s measuring inflation since 2019 or merely looking at it in comparison with one year ago.

“If your vantage point is 2019, inflation has definitely gone up,” Gascon said. “Risks appear tilted toward the upside.”