UBS economists expect the Federal Reserve to cut interest rates by 25 basis points (bps) in June, followed by another cut in September.

The Federal Reserve lowered interest rates by 25 basis points at its most recent Federal Open Market Committee meeting this month, in line with market expectations. This is the fourth rate cut since September, bringing the total reduction to 100 basis points, and setting the policy target range at 4.25%-4.5%.

However, the updated dot plot presents a more hawkish stance than expected. The median forecast now reflects only a 50 basis point reduction in 2025, significantly different from the 100 basis points shown in the September dot plot. The Fed's outlook indicates that policy adjustments may continue until 2027.

The market reacted negatively to this announcement. Stocks fell sharply, bond yields rose, and the dollar strengthened.

At the post-meeting press conference, Federal Reserve Chairman Powell expressed optimism about the economic situation and the outlook for 2025. Powell acknowledged that economic growth has exceeded the Fed's recent expectations, while inflation remains above the 2% target. Therefore, the Federal Reserve intends to adopt a more cautious approach to further rate cuts.

UBS senior economist Brian Rose stated in a note that our own view of the economic outlook is similar to that of the Federal Reserve, which is why we adjusted our rate cut forecasts based on the new dot plot.

The bank now expects the Federal Reserve to cut interest rates by 25 basis points in June and September, totaling a 50 basis point reduction by 2025, whereas the previous expectation was for quarterly cuts to reach 100 basis points.

While this more cautious approach is currently favored, Rose emphasized that 'if there are bad news regarding the labor market early next year, a rate cut in March may quickly reappear.'

The hawkish stance of the Federal Reserve has fueled a rebound in the dollar, with the dollar index briefly breaking above 108. This trend is consistent with interest rate movements over the past two years and is expected to continue until 2025.

Political factors, including Donald Trump's upcoming inauguration, may keep the dollar appreciated in the short term. However, UBS emphasizes the limitations of further strengthening of the dollar, citing overvaluation of the dollar, minimal expectations for U.S. monetary easing in 2025, and market focus on the positive aspects of Trump’s policies. Any factors deviating from these expectations could trigger a dollar pullback.

UBS views the current appreciation of the dollar as a selling opportunity, expecting the euro to fall back to 1.10 against the dollar later in 2025.

Last week, the Federal Reserve's tone became more hawkish. It expects inflation in 2025 to be higher than previously estimated and has reduced the expected number of rate cuts for next year. Neil Dutta, an analyst at Renaissance Macro, wrote that in an environment that seems to be slowing, the Federal Reserve may find itself in a difficult position and could revert to a more dovish stance. He suspects that expectations regarding the Trump administration's policies—acknowledged by Powell, who stated that some Fed officials are now considering them—will lead to changes in next year's forecasts, as the Fed 'seems to be taking precautions against potential tariff shocks by slowing the pace of rate cuts.' Dutta wrote, 'Given that the underlying momentum of the economy seems to have weakened, this (approach) is quite dangerous.'