Will the Federal Reserve continue its rate cuts in 2025?
Market participants anticipate a near-certain interest-rate reduction by the Federal Reserve in the upcoming week. Within the central bank, the rationale for ongoing reductions will become less definitive if the economy maintains its steady momentum. Recent indications from Fed officials suggest that a rate cut this week may mark the conclusion of the initial phase in a two-step process of rate reductions. During that initial period, policymakers maintained a modest threshold for reducing interest rates, given that they had previously set borrowing costs at a notably elevated level. They had additionally postponed their decision by several months to ensure that inflation was aligning more closely with their target—and trending downward.
In September, officials initiated a series of rate reductions, commencing with a substantial half-point decrease. The central bank implemented another reduction last month, decreasing rates by a quarter point. This week’s reduction would signify the third consecutive decrease. In the preceding year, authorities have gradually adjusted their forecasts regarding the eventual stabilization of rates, and further revisions may emerge in this week’s projections. There are indications that further reductions in borrowing costs will depend on more tangible proof of either an improvement in inflation or a deterioration in the labor market.
“We are approaching a juncture where it may be prudent to moderate the speed of rate reductions,” remarked Cleveland Fed President Beth Hammack earlier this month. She noted with approval two instances from the 1990s in which the Federal Reserve promptly reduced rates by a cumulative 0.75 points before adopting a more passive stance. Recent communications from the Federal Reserve indicate that officials are likely to adopt a more measured approach regarding future reductions in quarterly rate projections, as highlighted by remarks from Fed Chair Jerome Powell during a news conference on Wednesday.
Powell is encountering increasing reservations from colleagues who have expressed skepticism regarding reductions. Opting for the most straightforward approach, the Federal Reserve might consider implementing a rate cut this week, accompanied by forward guidance indicating that it may refrain from further reductions for one or more subsequent meetings. At their September meeting, officials anticipated four rate cuts for the upcoming year; however, their latest projections are expected to indicate one or two fewer reductions for 2025.
This week’s meeting is poised to intensify discussions surrounding two pivotal issues that may shape the trajectory of interest rates in the coming year: the positioning of the “neutral” rate of interest and the prospects for policy shifts under President-elect Donald Trump. The neutral rate is often regarded as the elusive benchmark, a point at which economic activity is neither stimulated nor restrained. Determining the precise position of that rate is not a simple task, as analysts present a spectrum of estimates.
As the Federal Reserve approaches estimates of neutrality, the rationale for rate cuts diminishes, particularly if inflation remains resilient and the labor market shows no signs of deterioration. Currently, various officials have suggested that the rationale behind last month’s reduction is expected to hold true at least one more time. “The rationale for a reduction lies in the belief that they remain significantly distant from a neutral stance, and…inflation appears to be trending downward,” remarked Dean Maki, chief economist at Point72 Asset Management.
Failing to implement a widely anticipated cut could further obfuscate the Fed’s intentions and rationale among investors. Recent trends in inflation and labor markets appear insufficiently significant to alter officials’ projections for one or two years hence, which are crucial when determining appropriate interest rate levels. Furthermore, even with an additional quarter-point reduction, interest rates would remain above the majority of credible assessments of neutrality, which range from approximately 2.5% to 4%. The current benchmark federal-funds rate set by the Federal Reserve stands at approximately 4.6%.
“It appears that there remains a further adjustment of 50 to 75 basis points ahead,” remarked Donald Kohn, a former vice chair of the Federal Reserve. Certain officials may resist additional cuts, believing that the economy does not justify lower rates and that current rates are nearer to neutral than many models indicate. Concerns may arise among officials regarding the ongoing reduction of rates amid a rapid increase in asset prices, including stocks and bitcoin, which could stimulate spending and hinder any further decline in inflation. “Are you really considering adding gasoline to that fire?” “I am uncertain,” remarked Kohn.
Skeptics of cuts appear to hold stronger convictions, as the labor market has not deteriorated to the extent anticipated at the close of summer. The recent momentum in inflation has come to a halt. “While the situation has not been dire, inflation has proven to be less contained than desired,” remarked Maki. The proposed alterations by Trump regarding trade, immigration, regulation, and tax policy have the potential to significantly influence the trajectories of growth, employment, and inflation in the years ahead. Officials are set to confront these changes during their meeting this week.
Increased deportations and a shift away from lenient immigration policies may lead to higher wages, yet simultaneously dampen demand. Tariffs may elevate prices, yet they could also compress margins, bolster the dollar, or dampen business sentiment. An increase in energy production may serve to mitigate price increases in other sectors. “There are numerous components at play here,” Kohn remarked in a recent interview.
In light of these uncertainties, Powell has indicated that the Fed ought to refrain from speculation or making conjectures regarding the impacts of these policies. During a recent address, Powell enumerated a series of uncertainties surrounding tariffs, such as the specific products and nations affected, the magnitude of the tariffs, the advance notice businesses might receive, and the potential reactions from other countries. “We must allow this to unfold,” he stated. Officials are expected to receive insights from staff economists regarding the possible economic implications across various scenarios. “We are currently developing a model for this….We are monitoring the situation closely. “However, the choices we are currently undertaking do not pertain to that,” Powell stated.
A consensus among various officials has emerged regarding that perspective. Atlanta Fed President Raphael Bostic informed reporters this month that he had instructed his staff to “wait as long as possible” before incorporating assumptions regarding policy changes into the bank’s outlook for the suitable configuration of interest rates. “The December meeting is undoubtedly premature for integrating” potential policy adjustments “into my personal perspectives or projections,” remarked St. Louis Fed President Alberto Musalem last month.
Some former officials argue that the Federal Reserve ought to factor in possible shifts in immigration and trade policies into their forecasts, as these levers can be adjusted without the need for congressional approval. Trump has signaled intentions to implement tariffs and initiate deportations from the outset of his administration. “It is challenging to assert that one will disregard an event anticipated for January 20 while formulating a forecast in mid-December,” remarked Eric Rosengren, former president of the Boston Fed from 2007 to 2021. Chicago Fed President Austan Goolsbee acknowledged the complexities of that balancing act. “I am not at ease with formulating policy grounded in political conjectures,” he remarked to reporters this month. “That being acknowledged, I do not believe we should adopt a solely reactive stance.”
