The latest inflation data may make the Federal Reserve more cautious about the pace of rate cuts, but not just yet.
Investors still generally expect the Federal Reserve to cut rates by 25 basis points next week, following a new report showing that inflation in November met expectations. However, persistent price pressures also highlight concerns that progress toward the Federal Reserve's 2% target may stall.
These concerns may prompt officials to rein in their projected number of rate cuts for 2025, as they need more evidence to confirm that inflation is moving toward their target. Federal Reserve policymakers will announce new economic and interest rate forecasts at the conclusion of their meeting in Washington on December 17-18.
Former Cleveland Fed President Loretta Mester said, "I think they can safely do a 25 basis point cut in December; the market is already prepared for that, but they must reconsider the pace of rate cuts for next year, as it now seems that progress on inflation has somewhat stalled."
Just three months ago, the Federal Reserve initiated a rate-cutting cycle, taking aggressive measures to cut rates by 50 basis points, due to growing concerns among officials that the cooling U.S. labor market was approaching a dangerous tipping point. Next week's rate cut will be the Federal Reserve's third consecutive cut this year, lowering the federal funds rate to a range of 4.25% to 4.5%, which is one percentage point lower than early September levels.
This is still well above policymakers' median expectation that the final rate in September will be 2.9%; they are simply less eager to reach that target.
This is because since September, the pace of inflation decline in the U.S. has been slower than expected, and the labor market has not been as weak as people feared. Officials, including Federal Reserve Chairman Powell, have responded by saying they are prepared to slow down the pace of lowering borrowing costs.
If policymakers maintain their September forecast, the Federal Reserve will cut rates four more times in 2025 after the December cut. However, many analysts expect that due to growing concerns about sticky inflation, the number of rate cuts in 2025 will be reduced, especially after the committee cuts rates next week.
Conrad DeQuadros, senior economic advisor at Brean Capital LLC, said, "Those dovish individuals hoping for significant rate cuts from the Federal Reserve will pay a price; the Federal Reserve will indeed continue to cut rates, but the future path of rate cuts will be more gradual."
Based on the pricing of federal funds futures, investors expect the Federal Reserve to cut rates in December and to cut rates two to three more times next year.
Julia Coronado, founder of MacroPolicy Perspectives and former Federal Reserve economist, agrees that some officials may reduce their forecasts for the number of rate cuts in 2025. Coronado said, "Compared to the baseline forecast from September, the Federal Reserve's pace of easing may be slower, and then the question becomes, 'Well, what about the timing?'"
Stronger data
The Labor Department's data released on Wednesday showed that core CPI inflation (excluding volatile food and energy prices) rose by 0.3% month-over-month for the fourth consecutive month, with a year-over-year increase of 3.3%.
Housing costs (a stubborn root of inflation) have cooled somewhat from last month. However, the prices of goods excluding food and energy (areas where costs have been declining) rose by 0.3%, the highest increase since May 2023. Traders raised the probability of a Federal Reserve rate cut next week to about 90%, up from around 80% before the inflation data was released.
James Athey, portfolio manager at Marlborough Investment Management, stated, "It now seems that the December decision is all but set; the Federal Reserve is not the kind of central bank that likes to surprise the markets."
Short-term U.S. Treasury bonds initially surged but gave back some gains later in the day. Given that the mixed November employment data released last Friday makes it more likely for the Federal Reserve to cut rates once more this year, bond bulls appeared more daring at the beginning of this week.
Stronger inflation data could also intensify questions about whether the neutral interest rate (the level of borrowing costs that neither slows down nor stimulates the economy) is now higher. If the neutral rate is indeed higher, it means that interest rates are exerting less downward pressure on the economy than expected.
Officials do not want interest rates to be so high that they damage the labor market, but they also do not want to cut rates too quickly, falling below the neutral rate and reigniting inflation. Powell stated last week, "As we strive to find the neutral rate, we can be a bit more cautious."
Article forwarded from: Jinshi Data
