The US Federal Reserve cut interest rates on Wednesday, with Chairman Jerome Powell warning that further reductions would depend on significant progress in tackling persistently high inflation.
Powell’s explicit – and repeated – references to the need to proceed with caution from here shook Wall Street, sending stocks sharply lower and prompting a reversal of market estimates for the likely size of the decline borrowing costs over the coming year.
“I think we’re in a good position, but I think from now on it’s a new phase and we’re going to be cautious about further reductions,” Powell said at a news conference after the end of the last two days of monetary policy from the Fed. meeting.
The Fed and Powell were widely expected to pursue a “hawkish” rate cut on estimates that policy easing in 2025 would be about half as much as the 100 basis points projected by policymakers three months ago . But by the time Powell finished speaking, a single 25 basis point cut for next year was reflected in market prices.
As expected, the Fed lowered its benchmark rate by a quarter of a percentage point to the 4.25% to 4.50% range, a move Powell called “tighter,” noting that the slower pace Rate cuts planned for next year reflected higher inflation. readings in 2024.
Indeed, the decision to cut rates sparked dissent from Cleveland Fed President Beth Hammack, who joined the central bank earlier this year and indicated she would have preferred to leave rates unchanged at this week’s meeting.
“Economic activity continued to grow at a solid pace,” with unemployment “remaining low” and inflation “remaining somewhat elevated,” the Federal Interest Rate Setting Committee said. central bank in its latest policy statement.
“In considering the magnitude and timing of further adjustments to the target range…the Committee will carefully evaluate incoming data, the evolving outlook and the balance of risks,” he said in new language which establishes a likely pause in rate cuts. from the meeting of January 28 and 29.
U.S. central bankers now predict they will make just two quarter-percentage-point rate cuts by the end of 2025.
That’s half a percentage point less in policy easing next year than officials forecast in September, with the Fed’s inflation projections for the first year of the new Trump administration dropping from 2. 1% in their previous projections to 2.5% in current projections – oh well. above the central bank’s 2% target.
Slower inflation growth, which is not expected to return to the 2% target until 2027, translates into a slower pace of rate cuts and a slightly higher end point of 3.1%, also achieved in 2027, compared to the previous “terminal” rate of 2.9. % seen in September.
Fed officials also raised their estimate for the long-term neutral interest rate to 3%.
“While the Fed chose to end the year with a third straight cut, its resolution for the new year appears to be one of a more gradual pace of easing,” said Whitney Watson, global co-head and co- chief investment officer of fixed income and investments. liquidity solutions for Goldman Sachs Asset Management. Watson added that “we expect the Fed to choose to skip a rate cut in January, before resuming its easing cycle in March.”
Trump’s uncertainty
The new policy rate is now one percentage point below the peak reached in September, when officials concluded that inflation was likely returning toward the 2% target and there were risks to the labor market in the event of maintaining an overly restrictive monetary policy for too long.
Since then, however, key measures of inflation have moved largely sideways, while low unemployment and stronger-than-expected economic growth have sparked debate among policymakers over whether monetary policy is as strict as previously thought – a debate reflected in the ever-increasing inflation rate. long-term estimate of the neutral rate over the past year of 2.5% to 3.0%.
The Fed, which raised rates aggressively in 2022 and 2023 to combat a surge in inflation, began its easing cycle in September with a half-percentage-point reduction in borrowing costs. It cut rates by a quarter of a percentage point last month.
The latest quarterly projections are the first since President-elect Donald Trump’s victory in the Nov. 5 election, which introduced a new level of uncertainty into the economic outlook given his campaign promises of tax cuts, tariff hikes customs and repression of illegal immigration. aspects that some analysts consider inflationary.
Trump doesn’t take office until Jan. 20, and Fed officials have said they can’t base monetary policy on campaign proposals that may or may not pass. Powell nevertheless said that some policymakers had taken into account “highly conditional estimates” of the effects of the new administration’s anticipated policies.
Fed staff have likely considered different scenarios, and policymakers’ projections show that growth will remain above potential at 2.1% next year, that inflation will remain above target for two more years, and that the unemployment rate will never exceed 4.3%.