On Wednesday, December 18, Federal Reserve officials made the third decision in the current year to cut their benchmark interest rate, but at the same time decreased the scale of expectations for continued monetary easing next year.
The Federal Open Market Committee voted 11-1 to cut the federal funds rate by a quarter point to a range of 4.25%-4.5%. Cleveland Fed President Beth Hammack did not support this decision, being a supporter of the point of view that the central bank of the United States should hold the cost of borrowing unchanged.
The new quarterly forecasts testified that several Fed officials are planning fewer decisions on cutting interest rates in 2025 compared to the previous vision regarding the appropriate actions of the US financial regulator. According to the media, these changes demonstrate an increasing level of caution about the extent to which the central bank of the United States can lower the cost of borrowing. Fed officials are probably beginning to perceive the current configuration of economic reality in the United States as a situation with a vector of the dynamic in the direction of fewer opportunities for further continuation of monetary policy easing.
Currently, representatives of the US central bank in the framework of the most common position among them expect that by the end of next year, the benchmark rate will be in the range of 3.75% to 4%. In this case, it means two-quarters of a percentage point of cuts. It is worth noting that the mentioned expectations are what corresponds to such a concept as an average estimate.
It is also noteworthy that only five officials of the central bank of the United States have stated that, in their opinion, the scale of lowering the cost of borrowing should be wider next year.
It is worth noting that most experts interviewed by the media assumed that next year the Fed would make three decisions on cutting interest rates. In this case, it is the officials’ projections of actions that are meant, not the specific moves explicitly.
The S&P 500 index and others showed a downward dynamic after it became known about the forecasts of the central bank of the United States regarding the continuation of easing monetary policy next year. At the same time, the yield of US Treasury bonds rose on the background of the relevant news.
Fed Chairman Jerome Powell, while talking to reporters at a press conference held after the decision on the cost of borrowing was made, said that on Wednesday the central bank of the United States lowered the policy rate by a whole percentage point compared with the maximum level of the corresponding indicator. He also noted that the policy stance of the US financial regulator is now much less restrictive. According to Jerome Powell, the central bank of the United States may be more cautious at present as part of considering further adjustments to its policy rate.
At the same time, during a press conference, the head of the Fed noted that policy is still significantly restraining economic activity. In the relevant context, he also stated that the central bank of the United States is still on track to continue the cut.
According to Jerome Powell, to further lower the cost of borrowing, the US financial regulator should see more progress in combating inflation. He stated that currently, inflation in the United States has been moving sideways.
Moreover, during a press conference, Jerome Powell was asked how the US financial regulator might respond to a potential tariff hike by the new administration of Donald Trump, who will return to the White House next month. He stated that some policymakers have begun to incorporate the likely impact of the growth of the mentioned indicators. It is worth noting that after winning the United States presidential election last month, Donald Trump confirmed his intention to raise tariffs on goods imported from other countries. Some experts suggest that the relevant plans may be partially implemented. There is also an opinion that Mr. Trump may use the so-called tariff threat as a kind of tool to achieve certain goals in negotiations with other countries. Besides, some experts warn that the implementation of such intentions may provoke an acceleration of inflation in the United States or even cause the stagflation scenario to materialize in the country.
According to Jerome Powell, the impact of the mentioned policy proposals is still highly uncertain. In this context, it is worth noting that the strategy of the Donald Trump administration in the economic space in general and the trade sector, in particular, is currently not a kind of fact and what can be called a definitively confirmed conception. Nowadays, experts can only speculate about the most likely actions based on preliminary statements, indirect signals, and hints. There will be more understanding on this issue after the inauguration of Donald Trump, scheduled for January 20.
The head of the Fed said that a lot is currently unknown about the actual policies. For this reason, according to him, it is very premature to draw any conclusions.
Policymakers have now lowered their benchmark lending rate by a full percentage point since mid-September. In September, the central bank of the United States cut the cost of borrowing by half a percentage point. This decision by the US financial regulator came as a surprise to many experts who expected the Fed to begin easing monetary policy as part of a less aggressive approach at the initial stage of the relevant process. In September, officials at the central bank of the United States were, in a sense, inspired by the decline in inflation. It is worth noting that the US financial regulator has been able to make significant progress in countering the rapid rise in prices. The corresponding statement is confirmed by statistical data. In June 2022, inflation in the United States was 9.1%. In November of the current year, the corresponding figure was fixed at 2.7%.
Moreover, the September decision on the definitely aggressive cutting of interest rates was impacted by the concern of Fed officials that the labor market is approaching a dangerous tipping point. Since then, the situation has changed. The labor market has demonstrated resilience. Payrolls have grown by an average of 173,000 over the past three months. The unemployment rate in the United States in November was recorded at 4.2%. This indicator has increased but still remains low in terms of historical standards. In the current month, Jerome Powell said that downside risks to the labor market appear to have receded.
As part of the updated forecasts, policymakers expect the unemployment rate in the United States to be fixed at 4.3% next year. They also revised upwards their projections regarding the US economic growth in 2025. In their opinion, the corresponding figure will be 2.1% next year. This is a slight increase in the indicator compared to the previous version of the forecast.
The latest data on the dynamic of prices in the United States has provoked fears that inflation may be stalling above the Fed’s target of 2%. Against the background of the corresponding negative prospects, some officials of the US central bank began to adhere to the opinion that the financial regulator should slow down the pace of lowering the cost of borrowing.
So far, there is no unambiguously common point of view among the representatives of the Fed regarding perspectives related to the further dynamic of inflation. Some officials of the central bank of the United States are confident that the mentioned indicator will move on a downward trajectory. One of the arguments in favor of the corresponding vision of the prospects is the expected slowdown in housing costs. Other officials are very cautious about the optimistic attitude of their colleagues. For them, the main circumstance of the current configuration of economic reality in the United States is that inflation is still above the Fed’s target of 2% and the final victory over intense price growth beyond the constructive framework has not yet taken place.
Nowadays, the consensus forecast of US central bank officials provides that inflation will be fixed at 2.5% at the end of next year. It is worth noting that in September they expected the mentioned figure to be 2.1%.
Also, officials of the central bank of the United States again raised their median estimate of where the policy rate will settle over the long run to 3% from 2.9%. They noted that after the coronavirus pandemic, there is considerable uncertainty about the so-called neutral rate, which does not stimulate economic activity and at the same time is not a deterrent in the context of the corresponding dynamic.
Some officials of the central bank of the United States suggest that the neutral rate has moved higher. If this opinion is correct, the US financial regulator can achieve the mentioned indicator by fewer lowering the cost of borrowing compared to initial expectations.
In the context of forecasting the further dynamic of inflation in the United States, the main uncertainty factor at present is the lack of a definitive understanding of exactly what strategies the Donald Trump administration will use in the framework of policies related to trade, immigration, and taxation. In this case, there are assumptions, but there are no final decisions. Some preliminary forecasts suggest that the actions of the Donald Trump administration may put upward pressure on inflation and constrain the labor market. However, these are nothing more than assumptions.
Jerome Powell stated that the Fed is modeling and evaluating Donald Trump’s proposals, but not yet incorporating them into decisions because it’s unclear what specific form the policies will take.
The central bank of the United States also announced it would cut the rate it pays lenders using its overnight reverse repurchase facility by 30 basis points. In this case, the RRP rate would be lowered by five basis points relative to the fed funds target range.
Returning to the topic of market reaction to the statements made by the US financial regulator on Wednesday, it is worth noting that the Dow Jones Industrial Average continues to show some kind of historical records against the background of the Fed’s comments. However, in this case, there is a very important and unpleasant nuance, which is that the mentioned records are negative. The specified index has been on a downward trajectory for the 10th day in a row. The corresponding tendency is related to that stock markets generally reacted negatively to the forecasts of the central bank of the United States regarding the continuation of cutting interest rates next year. These projections turned out to be less ambitious and less optimistic than the preliminary expectations. Disappointing markets always mean a drop in performance.
The Dow fell by 2.58% to 42,326.87. This decline is the worst since the 11-day slide in 1974.
The S&P 500 also showed a negative dynamic on Wednesday. In this case, the indicator fell by 2.95% to 5,872.16.
The Nasdaq Composite also did not show optimism. This figure fell by 3.56% on Wednesday, to 19,392.69.
DoubleLine Capital chief executive officer Jeffrey Gundlach, during a conversation with media representatives, said that risky assets and the highly valued stock market do not like the idea that cutting interest rates is less likely on both sides of the mandate. The expert also noted that Jerome Powell’s press conference signaled that there would be no aggressive lowering of borrowing costs in the United States. It was also separately underlined that the market is pretty much in sync with that.
The Dow’s losing streak began after it closed above 45,000 for the first time ever on December 4. The total losses of this index have since amounted to 6%.
David Russell, global head of market strategy at TradeStation, said in a media comment that there is no Christmas cheer from the Fed. The expert noted that policymakers see higher inflation and lower unemployment in 2024. According to David Russell, there is simply no reason to be dovish given that outlook.
Until Wednesday, the Dow’s downward trajectory was largely related to a rotation out of old economy shares and into technology stocks, a sector that the century-old measure underweights compared to broader market metrics. But the Fed’s decision was what can be called a sensitive surprise for the entire market.
In general, at present, the condition of the economic system of the United States can be described as good. This assessment does not deny the existence of problems and risks and also does not mean that the future in a symbolic sense will be exclusively sunny and filled with the warmth of wealth and prosperity. The US economy, which has had many different periods in its history, including very difficult and to some extent critical ones, now has prospects containing different probabilities, among others pessimistic ones. Inflation in the United States has not yet been defeated, which does not negate significant progress towards the corresponding goal. If, in the context of the current configuration of reality in its many dimensions, an attempt is made to determine the word that most accurately characterizes the future from the point of view of the present perspective of perception of the coming days, then this word is likely to be Uncertainty. It is worth noting that uncertainty is not only a factor in complicating forecasting but also what can be called a kind of naturalness of the prospects themselves. The policy of the Donald Trump administration remains a mystery in some ways. However, uncertainty is currently a kind of global situation. The world economy as a whole is facing prospects that are extremely difficult to unambiguously characterize and define as a kind of image of the future. In this case, a significant impact factor is geopolitical tensions, which are on an escalatory trajectory. The relevant state of affairs is obviously not what can be called a regional problem. A highly probable, but still potential, tariff tightening by Washington will increase tensions in the global trade sector. It is also obvious that the implementation of the corresponding scenario will have certain political consequences in the context of interaction between world capitals.
The potential deterioration of the situation in the Middle East as one of the forms of manifestation of the current geopolitical tension will mean an increase in oil and gas prices, increasing the burden on the US economy. During the election campaign, Donald Trump pledged to increase oil and gas production in the United States. He sees the mentioned measure as a way to decrease the corresponding prices and inflation in general. But so far, these are plans that have yet to be implemented. External uncertainty currently means obscurity for the US economy, which may become a new reality with more pessimistic circumstances and conditions. However, this does not envisage that an optimistic scenario as an actual state of affairs in the future is impossible.
As for the Fed’s actions, the latest economic data suggests that it is preferable to hold the current cost of borrowing until inflation, which has shown moderate growth in recent months, returns to a downward trajectory. The current forecasts of officials provide that the target of the central bank of the United States of 2% will be reached no earlier than 2027. Previous expectations had envisaged that this would happen in 2026.
