Investors are almost certain that the Fed will make its last rate cut of 2024 this week, but the bigger question is whether the Fed is ready to reduce expectations for rate cuts in 2025.
Everyone's attention will be focused on the so-called 'dot plot,' which is a chart updated quarterly showing each Fed official's forecast for the direction of the federal funds rate.
In September of this year, when the Fed initiated its first rate cut in four years, the dot plot revealed a consensus among officials for two more rate cuts in 2024 and four slight additional cuts in 2025.
However, after a series of stubborn inflation readings and cautious comments from Fed officials, the 2025 forecast is now in question. Some Fed watchers also expect that the policies of Trump's new administration will create more challenges for Fed decision-makers.
Former Cleveland Fed President Loretta Mester stated that the prediction of four rate cuts last year 'must be reconsidered' and forecast that the pace will 'slow down' in 2025. She believes that 'two to three rate cuts seem appropriate to me.'
Some Fed watchers disagree with this view, believing that Fed officials will stick to their estimate of four rate cuts in 2025.
"The overall story is that they still expect inflation to decrease," said Luke Tilley, chief economist at Wilmington Trust, who expects the median forecast for 2025 to remain at four rate cuts. "They still believe that interest rates are restrictive."
Fed Chair Powell has left enough room for the Fed to take a slower pace if needed. He stated in early December, "We can afford to be a bit more cautious," as the economy is stronger than previously expected in the fall.
The anticipated adjustment is due to two developments at the end of 2024 that surprised some economists:
First, the job market has not shown new signs of weakness. Second, inflation has remained sticky this fall, refusing to make the final descent toward the Fed's 2% target.
The latest evidence comes from last week's inflation data released by the Bureau of Labor Statistics, showing that the Consumer Price Index (CPI) rose 2.7% year-on-year in November, slightly up from 2.6% in October.
After stripping out the volatile food and energy costs, core CPI rose 3.3% year-on-year in November, remaining at the same level for the fourth consecutive month. Producer prices also unexpectedly increased in November, adding to the sequence of stubborn inflation data.
However, traders reacted positively to the new readings, further increasing bets on a Fed rate cut this week, pushing the probability above 95%.
Some also do not expect changes in the Fed's 2025 forecast. Tilley believes that the dot plot released on Wednesday will show that the median target interest rate forecast for the end of 2025 will remain between 3.25% and 3.5%.
He said, "Fed officials must acknowledge the recent slightly higher inflation numbers, but also pay attention to the state of the labor market, which, while volatile, has generally slowed down." Compared to most Fed members, Tilley is more concerned about the job market, believing that the likelihood of a recession due to a weak labor market is 35%.
Tilley also noted that labor demand is declining, with the six-month average of private sector job growth dropping to 108,000. He sees the labor market slowing to close to 100,000 jobs per month.
Wilmer Stith, the bond portfolio manager at Wilmington Trust, is another Fed watcher who expects four rate cuts to occur next year.
He expects Powell to say on Wednesday that the Fed has made progress on its inflation targets, particularly advancements in housing prices and other CPI subcategories. "All of these suggest the story that 'we are getting closer to the target,'" Stith said. As for any actions this week, "I think a 25 basis point rate cut is almost a done deal."
Some Federal Reserve officials provided an optimistic assessment of the inflation outlook. Richmond Fed President Barkin stated in mid-November that he expects inflation to continue to decline next year.
He attributed the recent flat core inflation to a more stringent comparison base from last year. He stated that inflation readings in the first quarter of 2025 may be better, as this year's first quarter readings were high—this development led officials to pause their thoughts at the time.
Chicago Fed President Goolsbee urged a more macro perspective during a speech in early December, noting that since inflation reached 9% in 2022, the U.S. has experienced a significant decline in inflation rates, the highest level since 1981. "I still believe we will reach 2%," he added.
But Mester stated that recent readings, including last week's CPI, should be enough for Fed officials to reconsider the path for 2025.
She said, "I think there will be a rethinking of the appropriate policy path for next year, aside from the fiscal policy actions that are known to be upcoming but not yet specified."
She added that a rate cut is still possible this week, as that is the market's expectation. However, there may be a pause after that in January. "They are more likely to act in December and then consider next year's matters."
Article reposted from: Jinshi Data