The Fed Set for a Third Consecutive Rate Cut! But Powell Ready to Hit the Brakes
3min read The Fed will finally release its year-end rate decision on Wednesday. Ahead lies not only another rate cut but also guidance on the future rate cut path (dot plot) and the latest economic forecasts, making it a year-end review for the Fed. But don't get too excited yet, considering the red-hot US economy and stock market, Powell might cool down the enthusiasm.
Expectations are already high. The market is convinced that the Fed will cut rates by another 25 basis points this time, marking the third consecutive rate cut and bringing the total cuts this year to 100 basis points. Despite recent mild inflation rebounding and core inflation stabilizing, alongside a slight uptick in the unemployment rate, the Fed is not in a hurry to shift its stance.
The real suspense lies in next year's monetary path, especially with Trump set to take office in January, becoming a major uncertainty for the global economy. Wall Street largely believes that the Fed might signal a pause in rate cuts this time, waiting to see the impact of Trump's policies on the economy. Hence, although this cut is happening, it might be a hawkish cut.
"The key question for the statement and press conference is the relative emphasis put on slowing the pace versus on decisions remaining meeting-by-meeting and data-dependent," Goldman Sachs' Chief Economist Jan Hatzius wrote in a report. "We expect to hear both messages, including an addition to the statement that nods toward a slower pace."
He believes the Fed will pause rate cuts in January and only cut rates twice in 2025, each by 25 basis points.
Nick Timiraos, who has almost accurately predicted every Fed move since 2022, also expressed that since September, the frequency and magnitude of rate cuts have raised concerns among some officials, fearing that rapid rate cuts might send incorrect market signals. Early rate cuts could keep inflation high and damage the Fed's credibility, while some of Trump's forthcoming policies might elevate inflation.
A Lagging Dot Plot
The dot plots released by the Fed over the past two years have proven to be quite inaccurate. For instance, in June, they predicted only one rate cut for the entire year, but now we are approaching the third cut (with one being a significant cut). In the September dot plot, officials broadly predicted 4-5 rate cuts for 2025, which might change again this time.
This raises doubts about the Fed's credibility, as their grasp on the economy seems to be less precise. However, overall, the resilience of the US economy has surprised many officials, indicating that even under certain restrictions, the economic performance remains robust.
Although Trump has not yet taken office, reducing domestic tax rates and enforcing global tariffs seem inevitable, which might further deteriorate inflation. Therefore, after a series of monetary easing policies, the Fed needs to control its monetary policy more cautiously, reflected in this dot plot.
Continue to Raise GDP forecast, Lower Unemployment Rate, Alert on Rising Inflation
The US economy has been consistently sending strong signals, despite some minor hiccups in nonfarm payrolls, which now appear negligible. Instead, inflation seems to be subtly returning. With Trump's pro-business policies in tow, the Fed is poised to fine-tune its outlook again.
Currently, it's anticipated that GDP growth forecasts for this year and the next will be slightly revised upward, and the unemployment rate is expected to be slightly revised downward (forecasted at 4.4% in June, while the November nonfarm data was 4.2%); the trickier inflation might need a slight upward revision, with a heightened alert on inflation resurfacing.
"We'll see them leaning into the direction of travel, to begin the process of moving up their inflation forecast," said Vincent Reinhart, BNY Mellon chief economist and former director of the Division of Monetary Affairs at the Fed. "The dots [will] drift up a little bit, and [there will be] a big preoccupation at the press conference with the idea of skipping meetings. So it'll turn out to be a hawkish cut in that regard."
Powell Might Signal a Pause
The Fed Chair always keeps open every decision-making process. No surprise, Powell is expected to hint at a pause in rate cuts at the next meeting but will emphasize maintaining an open attitude and discussing future policies incrementally. While he might be queried about the series of impacts following Trump's inauguration, Powell is likely to maintain his usual stance: acting only when these policies are clearly implemented. He will also commend the robustness of the US economy, allowing investors to enjoy a peaceful year-end. Of course, he might also pour cold water on the exuberant stock market, given its strong performance, needing to moderately adjust the market sentiment.
Overall, the Federal Reserve is set for a third rate cut while signaling a pause in rate cuts. However, the market will not be alarmed by this as the Fed is still expected to continue cutting rates next year, the question being just how many cuts. How this situation evolves will depend on Trump's formal inauguration in January, a calm before the storm.
Let's wait and see, and meanwhile, wish everyone a Happy New Year.
