Fed Cuts Interest Rates by a Quarter-Point, Signals Fewer Cuts Next Year

The Federal Reserve building in Washington on Nov. 13, 2023. Madalina Vasiliu/The Epoch Times

The Federal Reserve followed through on the third straight interest rate cut on Dec. 18, lowering the benchmark rate by 25 basis points to a range between 4.25 percent and 4.5 percent at the December policy meeting.

It also stated that it expects fewer interest rate cuts in 2025 as inflation pressures weigh on monetary policy.

Investors had overwhelmingly expected the U.S. central bank to cut interest rates.

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Since earlier in the year, labor market conditions have generally eased, and the unemployment rate has moved up but remains low. Inflation has made progress toward the Committee’s 2 percent objective but remains somewhat elevated,” the Federal Open Market Committee said in a Dec. 18 statement.

Cleveland Fed President Beth Hammack was the lone dissenting vote, preferring no rate cut this month.

The post-meeting statement was little changed, although the language was altered to “extent and timing” regarding interest rate decisions.

Financial markets were more focused on updates to the Summary of Economic Projections, a quarterly survey of policy and economic activity expectations in the coming year.

Policymakers expect two half-point rate cuts in 2025, signaling a more conservative approach to loosening monetary policy. They also forecast another 50 basis points worth of rate cuts in 2026.

The median policy rate is projected to be 3.125 percent in the next three years.

The Fed projects the broader economy’s real gross domestic product growth rate to be 2.5 percent this year, up from the September estimate of 2 percent. Officials forecast the economy to grow by 2.1 percent in 2025, 2 percent in 2026, and 1.9 percent in 2027.

Unemployment will be lower than expected, coming in at 4.2 percent this year, down from the latest prediction of 4.4 percent. The jobless rate is expected to be 4.3 percent over the next three years.

The Fed’s preferred personal consumption expenditure (PCE) inflation is anticipated to be higher: Next year, it could climb to 2.5 percent, higher than the September forecast of 2.1 percent. It will then ease to 2.1 percent and 2 percent in 2026 and 2027, respectively.

Core PCE, which strips the volatile energy and food categories, is also considered higher than initially projected in 2025 and 2026.

Data suggest that the economy could be enduring sticky inflation heading into 2025. Indeed, inflation has steadily risen since the Fed kicked off its easing cycle in September with a jumbo half-point rate cut.

The annual inflation rate ticked up for the second straight month in November, touching a four-month high of 2.7 percent. Looking ahead to the next consumer price index report, the Cleveland Fed is forecasting a 2.9 percent reading.

Prior to the Fed meeting, economic observers cautioned that the central bank could slow the pace of rate cuts in 2025 amid stubborn inflation pressures.

“The Fed will become increasingly reluctant to cut in the future, which is why we expect the pace of rate cuts to slow in 2025,” Bryce Doty, the senior vice president and senior portfolio manager at Sit Investment Associates, said in a note emailed to The Epoch Times.

Inflation Still in Focus for Fed

Inflation is still a major factor in the Fed’s policy decisions, with the uptick in key inflation reports being “the biggest factor” in the newest projections, according to Federal Reserve chair Jerome Powell.

The monetary authorities will continue to search for progress on inflation next year as “we have been moving sideways on 12-month inflation,” Powell said Wednesday.

“As we think about further cuts, we’re going to be looking for progress on inflation,” he told reporters at the post-meeting press conference.

Still, the central bank will be data-dependent when deciding on rate cuts next year rather than “because of anything we wrote down today.”

“We’re going to react to data. That’s just the general sense of what the committee thinks is likely to be appropriate,” Powell said.

Powell said when it comes to additional cuts, the Fed will be looking for further progress on inflation, and continued labor market strength. “And as long as the economy and the labor market are solid, we can be cautious as we consider further cuts,” he said.

Powell noted that he is pleased with the economy’s health, adding that “it’s pretty clear we have avoided a recession.”

Market Reaction

The financial markets tanked in response to the policy meeting.

The tech-heavy Nasdaq Composite Index led the decline, plunging 3.5 percent. The blue-chip Dow Jones slumped 2.6 percent and the S&P 500 dropped roughly 3 percent.

Longer-term U.S. Treasury yields rocketed, with the benchmark 10-year yield surging to 4.52 percent. The 20- and 30-year yields advanced to 4.78 percent and 4.68 percent, respectively.

The U.S. Dollar Index (DXY), a gauge of the greenback against a weighted basket of currencies, soared above 108.00. The index is up almost 6 percent this year.

Investors shrugged off the rate cut and concentrated on the shrinking number of planned rate cuts in 2025, says Chris Zaccarelli, the chief investment officer at Northlight Asset Management.

“Santa came early and dropped a 25-bps rate cut in the market’s stocking but accompanied it with a note saying that there would be coal next year,” Zaccarelli said in a note emailed to The Epoch Times.

According to Jamie Cox, the managing partner for Harris Financial Group, Wall Street should be pleased with a more measured strategy for lowering interest rates.

“The Fed knows that services inflation has been stubbornly sticky of late, so they need to let the first series of rates cuts soak, so they signal to markets that they are willing to stop, or even raise rates again, if inflation doesn’t cooperate lower,” Cox said in a note emailed to The Epoch Times.

Research Shows How Much Fed Lowered Inflation

The Fed has been pleased with the progress on inflation since officials began tightening monetary policy in March 2022.

While recent figures signal sticky inflation ahead, it has eased significantly since reaching the 9.1 percent peak in June 2022.

But how much did the central bank contribute to this disinflation trend?

A recent research paper titled “Good Policy or Good Luck? Why Inflation Fell Without a Recession” concluded that the Fed contributed “between twenty and forty percent” to the slowdown over the past two-plus years.

Economists Thomas Ferguson and Servaas Storm, relying on models produced by former Fed Chair Ben Bernanke and former International Monetary Fund Chief Economist Olivier Blanchard, determined that the central bank’s cumulative impact of monetary tightening helped lower the U.S. inflation rate.

“This paper analyzes claims that the Federal Reserve is principally responsible for the decline of inflation in the U.S,” they wrote in the paper, published by the Institute for New Economic Thinking.

“We compare several different quantitative approaches. These show that at most the Fed could plausibly claim credit for somewhere between twenty and forty percent of the decline.”

Other factors played a role in fueling the decline in inflation’s growth rate, the economists noted. The loosening of global supply-side constraints and U.S. dollar appreciation, which lowered import costs and weakened export demand for U.S. goods, helped the situation, they said.

Research showed that wages also helped the situation.

“A major reason why U.S. inflation fell is that the real wages of U.S. workers took a hit,” the paper reads. “That is, the inflationary process slowed down and the inflation rate declined, because America’s workers were, in general, unable to raise their nominal wages in line with the rise in the cost of living.”

Nominal (non-inflation-adjusted) wages have risen by 17 percent since January 2021. Real (inflation-adjusted) wages have dropped by about 3 percent in the same span.

However, while economists have lauded the Federal Reserve for its work tackling inflation, many Americans think that the central bank mismanaged the issue.

A recent Wallet Hub survey found that 44 percent of respondents think the Fed has tackled inflation badly. The poll also reported that 90 percent of respondents still think inflation is an issue, and 75 percent think price pressures are a more significant issue than the labor market.