At the December meeting, the U.S. Federal Reserve Open Market Committee voted to cut the Fed funds rate by another -0.25% to a new range of 4.25-4.50%. There was one dissent from member Beth Hammack, who preferred to keep rates unchanged.
The formal statement was minimally changed, with the insertion of “considering the extent and timing” of additional adjustments to rates. This obviously implies a slowed pace in rate cuts from the last release, which financial markets reacted a bit negatively to, unsurprisingly. Compared to the September edition, the quarterly Summary of Economic Projections (SEP) release showed a rise in expected Fed funds rates of 3.9% for year-end 2025 (from 3.4%), 3.4% for 2026 (from 2.9%), 3.1% for 2027 (from 2.9%), and 3.0% over the long term (up a tenth from 2.9%).
For a time, CME Fed funds futures were showing less-than-clear probabilities of a December rate cut, with odds falling as low as 50% in the weeks after the early November FOMC meeting, but back up to 98% this week pre-meeting. Easing expectations for next year have tempered dramatically, though, from a pace of at least one per quarter, to now only two, with the highest odds for June 2025 at 4.00-4.25% and December 2025 at 3.75-4.00%. This has come alongside sticky inflation readings to some degree, but also continued strong economic growth, and a balanced labor market (none of which seems to need more stimulus).
Economy. U.S. GDP growth for the 3rd quarter came in at 2.8%, while the Atlanta Fed GDPNow indicator estimates a stronger 3.2% for Q4. Robust growth continues in personal consumption, noted by an expected strong Holiday shopping season, as well as fixed investment, exports, and government spending. The SEP noted economic growth expectations for 2024 at 2.5% (from 2.0%), 2.1% for 2025 (from 2.0%), an unchanged 2.0% for 2026, and 1.9% for 2027 (down a tenth), with the long-term assumed growth level steady at 1.8%. While demographics and productivity in recent years point to trend growth of around 2%, some inputs include a reduction in government regulations (perhaps unappreciated as a growth driver, as written about recently by economist John Cochrane) and possible productivity enhancements from artificial intelligence. However, neither will be ready immediately.
Inflation. For the 12 months ending in November, headline CPI ticked up a bit to 2.7%, still held down by subdued oil prices, while core CPI ex-food and energy was steady at 3.3%. Trailing 12-month PCE inflation for the prior October increased 2.3% at a headline level and 2.8% for core. The SEP noted core PCE inflation expectations of 2.8% for 2024 (up from 2.6%), 2.5% for year-end 2025 (up from 2.2%), 2.2% for 2026 (up from 2.0%), and finally an on-target 2.0% for 2027. As noted, inflation remains higher than the Fed’s 2.0% core PCE target level, due to ongoing strength from shelter costs as well as services more broadly, tied to wage growth. More recently, there have been some secondary concerns surfacing due to strong economic growth leading to another price resurgence of sorts (even if nowhere near the pandemic-like extreme), not to mention potential price impacts from trade policy/tariffs from 2025 on. While the Fed regularly reminds us they don’t act in anticipation of future potential policies, no doubt the uncertainty about tariff-related import prices could give pause. (Interestingly, a few foreign central banks already appear to be making policy adjustments in reaction to potential U.S. policy actions, with the strong and potentially stronger U.S. dollar not the least of the complications.) Other than that, an easing policy encourages growth, with at least some inflation a common byproduct of that, pressuring it towards being stickier for longer as opposed to decelerating dramatically. Having inflation rise (again) is not a small worry for the Fed, particularly due to the embarrassing experience of the 1970s when inflation was thought tamed but reared its head again.
Employment. Labor conditions have been steadily slowing, but the sharp downward shift the Fed had worried about seems to have stabilized a bit, but not completely. The unemployment rate for November ticked back up a tenth to 4.2%, although that’s still quite low from a historical standpoint. The SEP noted the unemployment rate expectation for year-end 2024 at 4.2% (down from 4.4%), 4.3% for 2025 (down a tenth), unchanged 4.3% for 2026, and 4.3% for 2027 (up a tenth), with the long-term ‘normal’ unemployment rate pegged at 4.2%. Job growth remains decent, after a month or two of throwaway reports marred by labor strikes and hurricanes, although the household survey remains weak. There seems to be a much better match between job seekers and available jobs, which is positive, but coupled with future uncertainty around wage growth demands and the potential impact of reduced immigration that would cut labor supply in key industries, such as agriculture, construction, and lodging/food services, to name a few. Strength or weakness in labor continues to be the wildcard between the Fed easing or staying put.
In summary, to end the year, the Fed finds itself in a much better position than it was in a year or two ago, having trudged through a pandemic, a rapid but dramatic recession, and a multi-cause bout of inflation at levels not seen in decades. Today’s environment seems tame by comparison, but they not be quite ready to celebrate a victory (if central bankers ever do). While the rate of inflation still hovers above where policymakers want it, it’s not by much, and the tradeoffs of strong economic growth and a balanced labor market seem to be ones they’re happy to take for the time being, with an allowance for inflation to run ‘hot’ for perhaps another year. Their easing off the gas of policy moves on short-term rates and forward guidance of ‘data dependence’ reflects this, with a coasting down the road seemingly more appropriate. In fact, we may not be that far from the theoretical ‘neutral rate,’ somewhere in the 3-4% range, but that is usually only more obvious in hindsight.
While we appear to continue to be in the coveted ‘soft landing’ scenario, the domestic and global environment will no doubt bring challenges and surprises in the new year, as they always do. This may reflect as much of the fiscal discussion as the monetary, which have already been reflected more so in the long-term portion of the U.S. Treasury yield curve, which doesn’t appear to be too far from theoretical fair value for now based on long-term growth and inflation expectations.
Ryan M. Long, CFA
Director of Investments
FocusPoint Solutions, Inc.
Sources: CME Group, Federal Reserve Bank, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, FocusPoint Solutions calculations.
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Sources: Ryan M. Long, CFA; Director of Investments; FocusPoint Solutions, Inc.
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