The US Federal Reserve (Fed) began its rate-cutting cycle in September, cutting its policy rate by a massive 50 basis points (bp). The decision marked a significant shift in monetary policy, as it was the first rate cut in the US since 2020.

The size of the cut, coupled with comments from Fed Chairman Jerome Powell, suggests some concern about the state or direction of the labor market, and less concern about inflation, according to Wells Fargo.

“Powell pointed out in his press conference that the labor market is in a strong state, and the Fed’s decision is intended to keep it there,” Wells Fargo strategists wrote in a recent note.

Federal Open Market Committee (FOMC) members forecast the unemployment rate to rise slightly to 4.4% in 2024 and 2025, while GDP growth is expected to reach 2.0% annually over the same period.

According to Wells Fargo, this suggests "the labor market is cooling, but not dramatically."

“Notably, FOMC members also see inflation continuing to decline. We believe this scenario provides a basis for rate cuts, but questions remain about their size, especially for cuts projected for 2025,” they added.

However, the Fed's updated projections differ from market expectations. The market is reportedly pricing in 125 basis points of cuts for both 2024 and 2025, more than the Fed's median forecast of 100 basis points per year.

“With all but one FOMC member projecting no more than 100 basis points of cuts in 2024, markets are likely to face some disappointment,” the strategists continued.

"Market pricing calls for at least one 50 basis point cut in 2024 rather than two 25 basis point cuts, which we do not believe is appropriate given the current state of the labor market. Given Powell's comments, we do not believe the Fed sees this way either."

Looking ahead, strategists remain cautious about market expectations for the Fed's rate-cutting cycle, calling them "overly optimistic." They argue that a total of 200 basis points of cuts between now and 2025 would require a much worse economic environment than both their and the Fed's current forecasts.

“If the economy continues to move towards a gradual slowdown followed by a recovery in the second half of 2025 as we expect, we believe the September 50 basis point rate cut will likely be the only cut this cycle,” the note said.

Additionally, Wells Fargo thinks inflation could pick up again by mid-2025, which could limit the Fed's ability to deliver all the rate cuts it has been anticipating.

In their view, the more realistic scenario would be another 50 basis points cut in 2024 and 75 basis points in 2025.