First, the bottom line
• As widely expected, the Fed today announced a quarter-point rate cut to bring the central bank’s benchmark interest rate down to a range of 4.25–4.5%.
• The cut caps a year that saw policymakers finally step back from its tight monetary bias aimed squarely at arresting the most significant inflation surge in the United States in decades.
• Expectations had coalesced around another 25-basis point cut, a probability reinforced by the Fed’s September projections and subsequent comments from policymakers. That development was no surprise.
• Beyond the cut itself, much of the recent focus has been on likely changes in the forecasted path for rates for the coming year. Expectations had been reined in significantly, but the updated projections still served up at least a moderate surprise for the market.
• Investors have been pricing in a high probability of fewer cuts next year on the strength of recent economic data and strong hints dropped by policymakers that the tone within the Fed was shifting toward doing less than previously forecast. The futures market had already backed off the Fed’s September forecasts but still reflected a high probability of another 0.75% in cuts within the last week.
• In that regard, the Fed’s updated projections today represented an even sharper pivot than markets had anticipated, slashing their rate-cut forecast to just 50 basis points in 2025. The market’s reaction was immediate and unambiguous: stocks dipped on the news of higher for longer rates, and treasury yields edged higher.
“In balance”
• Underlying the Fed’s rate cut decision was an acknowledgment that policymakers view the risk posed by earlier weakness in the labor market has dissipated to a degree, while various gauges of inflation remain elevated.
• It’s the stickiness of inflation coupled with signs of labor market stabilization (with unemployment still quite low) that led to policymakers concluding that the risks to each component of their dual mandate are roughly balanced.
• The economy still appears to be growing above trend, but questions remain about its near-term trajectory. Will President-elect Trump’s business-friendly agenda provide another spark to growth next year? Will inflation pressures find a second wind, potentially exacerbated by promised tariffs on a range of imported goods? Either could give Fed policymakers reason to question the need for further rate cuts, even if they stop short of an outright reversal in course.
So, what’s in store from the Fed?
• The Fed introduced policy projections several years ago to expand their toolbox and provide greater transparency into their expectations for the trajectory of growth, inflation, and labor conditions and resulting impact on monetary policy.
• The magnitude of the change in its rate forecast for next year reflects not only the surprising resilience of the U.S. economy and frustrating stickiness of inflation but also the practical limits of the Fed’s proverbial crystal ball.
• The central bank’s ongoing stated commitment to data dependency is a reminder to take the projections with a grain of salt. Will the Fed be able to — or even need to — deliver the additional easing reflected in today’s projections? Maybe. Maybe not.
• The sticky inflation challenge likely holds the key, particularly in the absence of a much more pronounced slowdown in the pace of economic growth.• The Fed’s message for now is clear: rates are likely to remain a bit higher for longer than most were expecting. That could change, but not without meaningful progress toward the central bank’s inflation goal — a prospect that has proven to be tougher than many had expected — including those pulling the monetary policy levers inside the Fed.
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