The new inflation numbers will likely make the Fed more cautious about the pace of interest rate cuts — but not yet.
Investors still widely expect the US central bank to cut borrowing costs by a quarter of a percentage point next week after a new report showed inflation rose in November, in line with expectations. But continued price pressures have also highlighted fears that progress towards the US central bank’s 2% target will falter.
These concerns may prompt officials to rein in the number of interest rate cuts they expect in 2025 while awaiting further confirmation that inflation is on track to reach its target.
Policymakers are scheduled to issue new forecasts and interest rate forecasts at the conclusion of their meeting in Washington on December 17-18.
“I think they can safely go ahead and cut rates by 25 basis points in December and the markets are ready for that,” said Loretta Mester, former head of the Federal Reserve Bank of Cleveland. “However, they have to rethink next year, because progress on inflation now appears “It’s like he stopped for a while.”
Just three months ago, the Federal Reserve began its rate-cutting cycle with a sharp half-percentage-point cut, driven by growing concerns that the US labor market was approaching a dangerous turning point.
The next cut would be the Fed’s third straight cut, lowering the federal funds rate to a range of 4.25% to 4.5%, a full percentage point lower than its level at the beginning of September.
This is still well above the 2.9% average estimate given by policymakers in September at which they expect interest rates to eventually stabilize. But they are in no hurry to reach this level.
This is because inflation has fallen at a slower pace than expected since September, and the labor market has not weakened as much as feared. Officials, including Chairman Jerome Powell, responded by signaling their willingness to take the time to lower borrowing costs.
If policymakers keep their September forecasts unchanged, this would suggest four more cuts in 2025, following the cut in December. But many analysts expect the number to fall in 2025 due to growing concerns about the stability of inflation, especially if it goes ahead. The committee will move forward with lowering interest rates next week.
“Doves who want to lower interest rates will pay for it with a higher trajectory” in the forecast, said Conrad de Quadros, senior economic adviser at Brain Capital LLC. “We will get the reduction, but the path going forward will be a much shallower path.”
Investors, based on pricing in Fed funds futures, expect a rate cut in December, followed by two or three additional cuts next year.
Julia Coronado, founder of Macro Policy Perspectives and a former Fed economist, agreed that many officials may underestimate the number of cuts they see in 2025.
“It makes sense that they would have less mitigation in the baseline than in September. Then the question becomes, ‘OK, but what about the timing?'” Coronado said.
November data released by the Bureau of Labor Statistics showed that core consumer inflation, which excludes volatile food and energy costs, rose 0.3% for the fourth month in a row. Since last year, it has risen by 3.3%.
Shelter costs, a source of stubborn inflation, slowed from the previous month. But commodity prices excluding food and energy, the area where costs had been falling, rose 0.3%, the highest since May 2023.
Traders responded by raising the likelihood of the Fed cutting interest rates next week to around 90%, boosting those odds from around 80% before the inflation release.
“December now seems to be settled, and the Fed is not one of the central banks that likes to surprise the market,” said James Athey, portfolio manager at Marlboro Investment Management.
Short-term US Treasuries initially rose sharply before paring those gains later in the day. Bond bulls entered the week boldly given that Friday’s jobs data for November was mixed and made it more likely that the Fed would make another rate cut this year.
