Fed Watch – A hawkish cut, with sharp talons
The Fed cut policy rates by 25 bps in another non-unanimous decision, with Hammack dissenting in favour of no cut. The cut was contrasted by a significant tightening in the dot plot, which showed a median 50 basis points of easing in 2025, compared to 100 basis points of easing in 2025 in the September dot plot. This outlook is consistent with an upward revision in the Summary of Economic Projections, with the PCE inflation forecast for 2025 rising to 2.5 from 2.1 in September. In a remarkable change of message, Powell noted that some of the projections did make assumptions on future fiscal policy. However, others did not, and some did not disclose, which is explains both the uptick in the level and the uncertainty in the inflation forecast.
The hawkish cut led to strong market reactions, with stocks declining by about 2% just after the press conference, while 10 year yields rose by 10 bps, more than any of the FOMC meetings in the latest hiking cycle.
The press release now talks about 'in considering the extent and timing of additional adjustments,' compared with just 'in considering additional adjustments,' in the previous meeting. This language was previously used at the start of an extended pause, but Powell now described it as being at or near a point at which it's appropriate to slow the pace. It reflects higher inflation, and higher uncertainty around inflation, but overall, he feels the Fed is still on track to continue to cut. It simply signals the start of a new phase, where rate cuts come at a more moderate pace, with Powell noting that 'when the path is uncertain, you go a bit slower.'
When asked about the fact that Trump's election was the only major event since September, and therefore the clear cause for the inflation forecasts and their uncertainty increasing, Powell deflected and talked about the inflation even remaining much more persistent in 2024. Throughout the press conference he did however provide more details on his current take on potential tariff policy by the Trump administration. He reflected on the lessons from 2018, whilst also making it clear that the current economic situation is different, and especially reiterating that none of the details of tariffs are known. At the same time, they are preparing, and trying to assess the extent and persistence of the effect of tariffs on inflation.
The outlook for the Fed's trajectory in 2025 remains vague. Consistent with our base case, a pause in January seems almost certain, but beyond that little is known. Powell described a rate hike in 2025 as highly unlikely, but not impossible. Overall, he described the outlook by noting that the policy rate has now been reduced by 100 bps, and is significantly closer to neutral, but still meaningfully restrictive. Future decisions aim for further progress on inflation, without a significant deterioration in the labour market. The next three months may shift the balance again.