Update 832 — Fed Again Cuts Rates 25bp.
Econ. Expansion Seen Likely to Continue
With today’s 25 basis point interest rate cut, no surprise to most observers, the Fed has now brought rates down by a full percent in the last four months. But the inflation dragon has not been slain — recent PCE and CPI reports have indicated a modest backtracking on prices.
While the cuts are welcome, concerns about whether they can continue apace in 2025 are mounting with the Fed suggesting it will cut more slowly than previously expected in the coming year. Donald Trump’s promises (or threats) on tariffs, during and since the campaign, could imperil progress made this year on inflation. Still, the resilient U.S. economy’s expansion appears unlikely to be derailed. Details below.
Best,
Dana
Fed Cuts Interest Rates by 25 Basis Points
The Federal Reserve opted today to cut interest rates by 25 basis points to the 4.25 to 4.5 percent range in its third consecutive rate cut. This afternoon’s decision was broadly anticipated and came at the conclusion of the Federal Open Market Committee’s (FOMC) final meeting of the year.
According to economic projections released following the meeting, Committee officials expect that if the economy continues to move as expected, they will cut rates by 50 basis points next year, less than previously projected, bringing rates to about 3.9 percent by the end of 2025. This suggests two rate cuts of 25 basis points each over the FOMC’s eight meetings next year.
FOMC officials further projected they would cut rates to 3.4 percent by the end of 2026. The “dot plots” (see below), included in the FOMC’s economic projections, are collected from each member of the Federal Reserve Board of Governors and each Federal Reserve Bank president at every other FOMC meeting, reflecting their expectations of future economic activity and outcomes, as well as appropriate monetary policy, given their assessments of current economic data.
FOMC Participants’ Assessments of Appropriate Monetary Policy: Midpoint of Target Range or Target Level for the Federal Funds Rate (December 18, 2024)
Source: Federal Reserve, Summary of Economic Projections, December 18, 2024
Committee officials’ latest set of economic projections suggest that they may be slower to cut interest rates over the next year than they previously expected. In their last set of economic projections issued in September, officials projected that they would cut rates to 3.4 percent by the end of 2025, which suggested four rate cuts of 25 basis points each over its eight meetings next year. In September, officials also projected rates would be cut to 2.9 percent by the end of 2026.
In his press conference following the FOMC’s meeting today, Federal Reserve Chair Jerome Powell noted that the “ projections are somewhat higher than in September, consistent with a firmer inflation projection,” suggesting that Committee officials expect higher-than-previously-anticipated inflation over the next year to slow the pace of their interest rate cuts in 2025.
Given the expected slower pace of interest rate cuts in the coming year and the FOMC’s recent rate cuts of 100 basis points in its last three meetings, it is likely that Committee officials will opt to hold rates steady in January.
Economy’s Evolution through the Interest Rate Cycle
Today’s rate cut comes as the Fed continues to bring interest rates down from a two-decade high. The FOMC began raising the federal funds rate from near zero in early 2022 to peak levels reached in July 2023 in an effort to combat rising inflation. The Committee raised rates to the 5.25 to 5.5 percent range in its most aggressive series of rate hikes since the 1980s, then held rates steady at this elevated level from last July to this September when it finally began lowering rates with a 50 basis point cut. The Committee then cut rates by 25 basis points at each of its next meetings, taking interest rates down by a total of 100 basis points to their current level – the 4.25 to 4.5 percent range.
At the same time, inflation has made significant progress since the Fed initiated its cycle of rate hikes but remains stubbornly above its two percent target. The Fed’s preferred inflation gauge, the personal consumption expenditures (PCE) index, peaked at 7.1 percent in mid-2022. Core PCE – which strips out food and energy prices – peaked at 5.6 percent in mid-2022. In October, both headline and core PCE ticked up from the previous month to 2.3 and 2.8 percent respectively.
The median FOMC official projected that core PCE would come down to 2.5 percent next year before falling to two percent in the longer run — higher than projected by the Committee in September – meaning that Committee officials may be more inclined to cut rates at a slower pace than previously projected. Despite this elevated projection, Powell indicated at his press conference this afternoon that the FOMC sees inflation as moving “broadly on track.” He said that “twelve-month inflation has actually been moving sideways as we are lapping the very low readings of late last year.” Importantly, he noted that housing services inflation, which had been keeping inflation high over recent years, “is actually steadily coming down now, albeit at a slower pace than we might like.”
The elevated interest rate environment of the last year has played a role in bringing inflation down but the still-strong labor market has begun showing signs of weakness. The unemployment rate, while still historically low, ticked up to 4.2 percent last month, with the prime-age employment rate falling from 80.9 percent in October to 80.4 percent in November. Strong job gains over the beginning of this year have also moderated, wage growth has eased, and the jobs-to-workers gap has narrowed. While the labor market remains strong, this cooling is part of a sustained and ongoing trend. The median FOMC official projects that the unemployment rate will tick up to 4.3 percent next year. As Powell remarked, “the labor market is looser than pre-pandemic and is clearly still cooling further, so far in a gradual and orderly way.”
Growth has also remained resilient in the face of the Fed’s cycle of interest rate hikes. The United States economy grew by a healthy 2.8 percent on an annualized basis in the third quarter and by 3.0 percent in the second quarter of 2024. Consumer spending growth has also been resilient. Committee officials projected that GDP growth will remain solid, with the median official projecting that the economy will grow by roughly two percent over the next few years.
Overall, inflation has fallen but remains sticky above the Fed’s target, the labor market and economic growth have remained resilient, and the Fed has begun lowering interest rates as we close the year. As a result, heading into 2025, inflation’s stubbornness is likely to push FOMC officials to show restraint in cutting rates until data shows inflation ticking down.
Variables in an Uncertain Path Ahead
This week’s meeting is not only the FOMC’s final meeting of the year but also its last before President-elect Donald Trump takes office in January. The path ahead for inflation and the Fed’s interest rate decisions is uncertain as we head into next year.
Trump Proposals Point to Higher Inflation?
Powell and Fed officials have continued to avoid speculation about the potential economic impact of Trump’s proposed mass deportations, tariffs, and erosion of the Fed’s political independence and how this could affect future interest rate decisions. These proposals could increase inflation to as high as 6.0 to 9.3 percent in 2026, according to estimates by the Peterson Institute for International Economics. Such an increase in inflation would derail the progress made over the past year and could lead FOMC officials to hold interest rates at an elevated level for a prolonged period.
Trump Has Threatened Fed Independence
During his first term, Trump clashed with Powell after he appointed him to chair in 2018 and claimed that he had the right to fire him. Earlier this year, Trump baselessly accused Powell of considering rate hikes geared to help Democrats in the coming election, even as Powell consistently ignored calls by Congressional Democrats to lower rates over the year prior. Powell has affirmed the President is not permitted under the law to fire him before the end of his term which concludes in 2026 and that he will not resign.
The FOMC meets next to determine the fate of interest rates on January 28 and 29, 2025.