Fed cuts by 25bps. Expect some time before the next one

The US Federal Reserve, in its final meeting of the year, has opted to cut its benchmark policy rate by 25 basis points. However, the decision may have been made with some reluctance, with predictions the rate easing cycle will likely slow from here in response to favourable economic data.

The US policy rate ends the year at 4.25%, down from 4.5%, after the Fed’s third consecutive reduction in as many meetings since July.

However, with the Open Market Committee (FOMC), the Fed’s policy rate decisioning body, acknowledging strong economic data and a stubbornly “elevated” rate of inflation, as well as inflation uncertainty from the incoming Trump administration’s policy proposals, the decision to cut may have been made with some hesitation, argues Seema Shah, chief global strategist at Principal Asset Management.

She notes Fed chair Jerome Powell’s signalling of a likely slowing of monetary easing, with a “just two more 25bps cuts in 2025 (versus four cuts in the September dot plot)”. This is down from 100 basis points projected in the September median economic projections of Fed board members.

The slight pullback comes in response to median forecasts in the Summary of Economic Projections (SEP) which showed upward revisions to growth (up from 2.0% to 2.5% for GDP forecasts for 2024) and inflation (with the core PCE forecast raised from 2.2% to 2.5% in 2025, only returning to the 2% target in 2027), and downward revisions to unemployment (from 4.4% to 4.3% in 2025, where it will stabilise for a number of years).

“Since the Fed started to reduce rates three months ago, economic activity and labour market data has strengthened, and inflation progress has stalled,” Shah wrote.

“Furthermore, tariff and immigration proposals from President-elect Trump have raised fears of a renewed increase in inflation next year.

“Against that backdrop, Fed speakers have been sounding increasingly cautious, pointing out that there is no need to rush policy rates to neutral and instead a more patient approach may be warranted.”

For Shah, the “outsized” 50bps cut, made in mid-September, may have been too much, too soon.

On the potential inflationary impact of the incoming administration’s tariff proposals, Powell, Shah noted, “emphasised the uncertain nature of the impact”. However, he noted that all FOMC members were undertaking rigorous analysis to promptly respond if and when the policy is enacted, conceding that some FOMC members may have already incorporated these policies into their economic projection revisions.

Shah concludes that, ultimately, “the economic and inflation backdrop is not one that screams a need for meaningful policy stimulus, and tariff policy uncertainty implies that the Fed now needs to tread very cautiously”.

“We expect the Fed to slow its cutting pace, passing on January and waiting until the March meeting before lowering policy rates again. Evidence of cooling labour demand suggests to us that the Fed is likely to cut policy rates three times next year (rather than the two included in the dot plot)—however, it is not difficult to imagine a scenario whereby new tariffs prompt the Fed to enter a prolonged pause period.

“Policy uncertainty is particularly elevated going into 2025.”