Sticky Inflation Raises Questions About Fed’s Rate Cut Plans
The latest inflation readings have cast doubt on the Federal Reserve’s ability to meet its 2% inflation target, leaving investors wondering how deeply interest rates will be cut in 2025. Despite a lack of progress, economists believe the Fed will still cut rates, but at a slower pace than initially forecast.
Core Inflation Remains Sticky
The core Consumer Price Index (CPI) and Producer Price Index (PPI) both showed prices increasing by 3.3% and 3.1% respectively in October, indicating persistent inflation in the economy. This marks the third consecutive month of sticky inflation, raising concerns about the Fed’s ability to meet its target.
Fed’s Outlook Uncertain
Economists do not expect the recent data to change the Fed’s outlook, with the CME FedWatch Tool predicting an 80% chance of a 25-basis-point rate cut in December. However, the lack of progress on inflation could lead to adjustments in the Fed’s Summary of Economic Projections, which had forecast four rate cuts in 2025.
Markets Shift Expectations
Over the past two months, markets have quickly shifted to reflect a slower pace of easing. The Federal Funds rate is now expected to be around 2.2% by the end of 2025, compared to 3% previously. This shift has led to a large increase in bond yields, with the 10-year Treasury yield adding 80 basis points since September.
Stock Market Resilience
Despite the increase in bond yields, the stock market has remained resilient, with all three indexes nearing record highs. Investors attribute this to stronger-than-expected economic data, which has offset the impact of rising yields.
Economists Weigh In
Oren Klachkin, Nationwide financial markets economist, notes that the PPI data makes the policy outlook murkier, while Wolfe Research chief economist Stephanie Roth believes the Fed will need to adopt a slower pace of easing. Meanwhile, Bridgewater Associates co-chief investment officer Karen Karniol-Tambour attributes the market’s resilience to stronger economic growth.
Fed Chair Powell’s Comments
At his recent press conference, Fed Chair Jerome Powell acknowledged that inflation is coming down on a “bumpy path,” but declined to provide forward guidance on the Fed’s path. Economists are taking hints from recent trends within the inflation prints, which suggest a slower pace of easing may be necessary.
Looking Ahead
The next key indicator will be the release of the core Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation gauge, at the end of November. Economists expect this to show core prices rose 2.8% in October, up from 2.7% in September. While this doesn’t mean markets should panic, it does suggest that the risk appears to be tilting toward a shallower cutting cycle given resilient economic activity and stubborn inflation.
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