Federal Reserve Cuts Interest Rates, But Cautions on Future Reductions
The US central bank has cut interest rates, as anticipated, but Federal Reserve Chair Jerome Powell has signaled that further reductions in borrowing costs will depend on significant progress in tackling stubbornly high inflation. This cautious approach has sent shockwaves through Wall Street, leading to a sharp decline in stocks, higher bond yields, and revised estimates of future borrowing costs.
A New Phase of Caution
Powell emphasized the need for prudence, stating that while the economy is in a good place, the Fed must be cautious about further cuts. He highlighted the improvements in inflation since 2022, but also noted its disappointing sideways movement in recent months, particularly in shelter costs. Although the Fed remains confident that price pressures will ease, Powell acknowledged that policymakers are starting to consider the potential impact of President-elect Donald Trump’s policies on the economic outlook.
Reckoning with Trump’s Policies
In developing new projections, some policymakers have begun to incorporate estimates of the economic effects of Trump’s policies, including higher tariffs, tax cuts, and tougher immigration policies. This has led to a shift in the Fed’s outlook, with a higher inflation forecast and fewer rate cuts expected next year. The new projections show officials expect core PCE inflation to remain stuck at 2.5% through 2025, significantly higher than the Fed’s 2% target.
Uncertainty and Upside Risks
The Fed’s new projections also reveal a significant increase in uncertainty and upside risks to core PCE inflation, largely driven by the potential impact of Trump’s policies. This has led analysts to conclude that the Fed is starting to reckon with the potential inflationary pressures of these policies.
One Dissent and a Changed Outlook
The Fed’s decision to cut interest rates was not unanimous, with Cleveland Fed President Beth Hammack dissenting and advocating for no change in rates. The changed outlook highlights the challenges Trump may face in delivering on his campaign promises, with tighter Fed policy likely to keep consumer interest rates elevated and less improvement on inflation undermining his pledge to lower prices.
A Baseline Outlook for Growth
Despite the caution, Powell emphasized that the baseline outlook is for the economy to continue performing well, with ongoing growth, low unemployment, and inflation that officials expect to drift slowly lower. Rates will fall again once inflation shows more progress, but the extent and timing of additional adjustments will depend on incoming data and the evolving outlook.
A Likely Pause in Rate Cuts
The Fed’s new language suggests a likely pause in rate cuts beginning at the January 28-29 meeting, with policymakers now projecting just two quarter-percentage-point rate reductions by the end of 2025. This is half a percentage point less in policy easing next year than officials anticipated as of September.
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