FOMC Preview – Easing between a rock and a hard place

This Wednesday sees the final FOMC meeting of the year, where we expect the Fed to continue its easing cycle by cutting rates by another 25bps, putting the upper bound of the federal funds target rate at 4.50%. It marks the closing of a volatile year in terms of expectations about the Fed policy path. Market pricing for the end-of-year policy rate ranged between 3.50% in the start of the year, up to 5.00% at the end of April, back down to 3.75% during September – around the initial 50bps cut that started off the easing cycle - to ultimately settle at 4.50% as of today.

We didn’t see the initial 50bps cut as necessary then, and data since has not made the case stronger. Back in September, Powell noted his confidence that inflation was coming down hinged on all components of inflation coming down, contrasting it with the disinflationary episode at the end of 2023. Indeed, at the time of easing, the 3m/3m SAAR inflation rate stood at around 1%, and the decline was broad-based across contributing components. The three inflation releases since then show a clear upward trend, with also non-housing services inflation picking up again. The 3m/3m SAAR headline and core CPI rate now stand at 2.5 and 3.4%. The latest monthly figures are achingly close to 4% annualized. While the upcoming PCE inflation reading is likely to be more benign – we nowcast core at 0.1% m/m – the December reading is likely to be on the firmer side again through financial services inflation, on the back of strong equity growth. Disinflation appears to have at the very least stalled, and the threat of inflationary government policy in the near future leaves little room to become very optimistic on the prospect of inflation returning to target. Rates will have to remain restrictive for some time.

The steady weakening of the labour market was the second reason for the start of the easing cycle, with Chair Powell stating ‘We do not seek or welcome further cooling in labour market conditions.’ Since then, non-farm payrolls saw great volatility, with the November reading of 227k jobs added largely making up for the extremely low October reading, which was driven by the effects of hurricanes and strikes. This volatility increases the importance of looking through the monthly data, and the trend suggests job gains have settled at a level between 100 and 200k, below the likely ‘breakeven’ pace that would keep the unemployment rate steady. Moreover, changes in the number of people employed, based on the household survey, saw a strong increase in September, but two very weak readings since. Consistent with that, the unemployment rate has edged up again to 4.2%. Hiring and quits rates are near decade lows, suggesting little job seeker confidence and opportunity. The overall picture is one of cooling with a variety of labour market indicators suggesting it has indeed cooled beyond the state at the onset of the pandemic. Even if job creation stays at this pace, the unemployment rate is expected to slowly edge up over the coming year, but we do not expect the labour market to significantly and rapidly deteriorate. At the same time, it is clear that the risk is tilted to the downside.

The Fed is therefore in a difficult position, with the dual sides of their mandate, price stability and full employment, pulling in different directions. Inflation is stabilizing at a level that’s too high, but is at least not yet really increasing. The labour market is still in the process of further slowing down. Given the long lags of monetary policy, the likely policy response therefore remains to gradually ‘recalibrate’ the policy rate towards neutral, letting the still restrictive rates continue to press on economic activity to get inflation down, while limiting the downside risk to the labour market. Market pricing has already moved substantially since the last meeting, and it’s likely the Fed is comfortable with the much more cautious currently priced trajectory. We continue to expect that the Fed will cut rates by 25bps this meeting, but slow the pace during 2025, carefully balancing the incoming data. For now, we have put in 100bps of cuts for 2025, one 25bps cut every second meeting, ending 2025 at 3.50%. The dot plot will likely shift hawkish compared to September, on the back of the abovementioned data developments. During the press conference, Chair Powell will certainly be asked about any potential Trump effects in the economic projections, but he has previously been firm that they do not speculate on uncertain future policy. In any case, the timing and ultimate implementation of the Trump administration’s policy proposals will play a key role in shaping the actual trajectory of the policy rate.