On December 18, 2024, the Federal Reserve made its expected move by lowering interest rates by 25 basis points, with the target range now between 4.25% and 4.50%. This marks the third consecutive rate cut since September 2024, which has brought cumulative reductions to one full percentage point. Despite the rate cut, the decision was not unanimous among the Fed's policymakers, signaling differing perspectives within the Federal Open Market Committee (FOMC).
The markets reacted negatively to the announcement, with the Dow Jones Industrial Average seeing losses of 2.58%, the S&P 500 dropping 2.95%, and the tech-heavy Nasdaq Composite shedding 3.56%. The downturn indicates investor disappointment, primarily due to the Fed's more conservative view on future rate cuts. Previously, the Fed had signaled the possibility of four cuts next year; now, it has only projected two cuts, each by 25 basis points, for 2025. This shift highlights the challenges the Fed faces with inflation, which remains stubbornly high.
Core inflation expectations have been revised upward, now forecasted at 2.8% for 2024 and 2.5% for 2025, contradicting previous hopes of aligning more closely with the 2% target established by the Fed. Jerome Powell, the Fed's Chair, emphasized the need to monitor inflation closely, stating, "We need to see more progress on reducing inflation as it has exceeded previous projections." The market's response to these comments was swift, showcasing investors’ concerns about prolonged inflationary pressures.
This inflation is largely fueled by factors such as housing costs and the anticipated economic policies of President-elect Donald Trump, who takes office on January 20, 2025. Trump’s plans, including potential tariff increases and deregulation, could pose significant inflationary risks, creating uncertainty for the Fed's future policies. The Fed's current stance reflects this unease, with Powell noting, "We're getting closer to the neutral rate, which neither supports nor hinders economic activity. The correct placement of this rate is still uncertain."
According to various sources, this revision indicates the Fed's cautious approach, as reactions from Wall Street suggest a lack of confidence moving forward. CNN reported, "The markets dropped sharply after the announcement of the Fed's statement, signaling investors' discontent with the new rate forecasts." Similarly, El País commented on how the Fed dampened hopes for aggressive cuts, highlighting the shift to more stringent monetary policy as inflation rates show signs of resurgence.
The FOMC's decision reflects multiple factors at play within the economy, including the overall unemployment rate, which is projected to remain stable around 4.2% through 2025. While the job market has shown resilience, concerns remain high about inflation's effect on consumer purchasing power.
When Powell was questioned about inflation during the conference, he noted, "Inflation has slowed significantly over the last two years, but it remains relatively high compared to our long-term target of 2%.” The Fed anticipates inflation will not return to its target until at least the end of 2026, making the search for balance between encouraging growth and curbing inflation ever more challenging.
The economic outlook for 2025 is projected with cautious optimism, with growth expected at 2.1%. This is slightly higher than earlier predictions but tempered by rising inflation expectations. The Fed believes it can afford to be "a bit more cautious" due to the current economic strength, underscoring Powell's comments on the necessity of fine-tuning future monetary policy amid potential political disruptions.
Wall Street's volatile response to these economic indicators and projected changes indicates the broader uncertainty looming over investors as they adjust to shifting federal policies. Observers, including economists from Capital Economics, are voicing concerns about the Fed's ability to predict the inflationary outcomes of new administration policies. They maintain, "The Fed appears to be incorporating the potential economic effects of new policies, and they could create significant shifts across the economy."
While some members of the FOMC voiced their disagreement with the current strategy, emphasizing caution against the background of inflationary pressures, it remains clear the Fed is bracing for complications. With Trump set to take office and bring his economic agenda to fruition, both the Fed and market investors will need to adapt quickly to the coming changes.
Overall, the Federal Reserve's recent rate cuts and outlook on inflation reveal the delicate balance it must maintain to support economic growth without allowing inflation to spiral. The anticipated changes coming with the new administration only add layers of complexity, requiring constant adaptation from both the central bank and market participants.
