Federal Reserve Holds Rates, Anticipates 2 Rate Cuts Amid High Uncertainty

The Federal Reserve has decided to maintain its current stance, stating that while economic uncertainty has decreased, it remains high. The central bank still anticipates two rate cuts this year, hinting at an increased risk of stagflation.

On June 18, the Federal Reserve announced that it would keep the target range for the federal funds rate unchanged at 4.25% to 4.5%. This marks the fourth consecutive meeting where the Federal Open Market Committee (FOMC) has chosen not to take action. The Fed had previously reduced rates by a total of 100 basis points over three meetings starting in September of last year. Since January, when the current administration took office, the Fed has remained inactive.

Investors had widely expected the Fed to hold rates steady. By the close of trading on Tuesday, tools from the CME Group indicated that the probability of the Fed keeping rates unchanged this week was 99.9%, and the probability of no rate cut in July exceeded 85%. The probability of at least a 25 basis point rate cut in September was slightly above 63%. Recent data on U.S. CPI and PPI for May showed signs of easing inflation, fueling expectations of two rate cuts this year.

This decision by the Fed is largely consistent with its previous stance, but it acknowledges that economic uncertainty has somewhat diminished. The dot plot, which reflects the Fed's expectations for interest rates, shows a more hawkish outlook for rate cuts this year, as the number of officials expecting no rate cuts has increased.

In its statement, the Fed reiterated its commitment to reducing its holdings of U.S. Treasury securities, agency debt, and agency mortgage-backed securities (MBS). Since April, the Fed has slowed the pace of its quantitative tightening (QT) by reducing the monthly redemption cap for U.S. Treasury securities from 250 billion to 50 billion, while keeping the cap for agency debt and agency MBS at 350 billion. The Fed has not changed its guidance on QT in the past two meetings, indicating that the process will continue at the current pace.

All voting members of the FOMC supported this week's decision. The statement also noted that while net exports have affected data, recent indicators show that economic activity continues to expand at a moderate pace. The labor market remains robust, and inflation is still elevated.

The Fed's economic projections show that officials have lowered their GDP growth forecasts for this year and next, while raising their expectations for unemployment and PCE inflation for the next three years. Specifically, the GDP growth forecast for 2025 has been reduced to 1.4% from 1.7%, and the unemployment rate for 2025 is expected to be 4.5%, up from 4.4%. The PCE inflation rate for 2025 is projected to be 3.0%, up from 2.7%.

Despite these adjustments, the Fed's median interest rate projections for the end of 2025 remain unchanged at 3.9%. The projections for 2026 and 2027 have been raised to 3.6% and 3.4%, respectively, from 3.4% and 3.1%. The longer-term federal funds rate is expected to be 3.0%, unchanged from the previous projection.

The updated dot plot shows a more divided Fed, with seven officials now expecting no rate cuts this year, up from four in the previous projection. Eight officials expect two rate cuts, down from nine, and two officials still expect three rate cuts. Overall, the number of officials expecting at least one rate cut this year has decreased from 16 to 12.

In summary, the Fed's decision to hold rates steady reflects a cautious approach to monetary policy, acknowledging the reduced but still high level of economic uncertainty. The central bank's projections suggest a more hawkish stance on rate cuts, with a focus on maintaining price stability and full employment. The Fed's continued QT and its commitment to reducing its balance sheet further underscore its determination to manage inflation and support economic growth.