Is it a foregone conclusion that the Federal Reserve will cut interest rates early Thursday? The 2025 interest rate plan may see new twists!

According to the Zhitong Finance APP, Federal Reserve officials are set to discuss borrowing costs at this week's meeting, with the market widely expecting another interest rate cut, although the reduction may be smaller than previously anticipated, while also suggesting that the pace of rate cuts will slow down next year. The resilience shown by the U.S. economy has exceeded officials' predictions from a few months ago, with inflation declining at a slower pace and the labor market not being as weak as expected. This shift in economic outlook may prompt the Federal Reserve to adjust its wording in Wednesday's policy statement and raise expectations for the path of borrowing costs. Additionally, stronger-than-expected data has sparked discussions about whether the neutral interest rate should be raised, which could serve as a rationale for the Federal Reserve's gradual rate cuts. The Federal Reserve's interest rate decision and the latest quarterly economic forecast report will be released at 3 AM Beijing time on Thursday. Following that, Federal Reserve Chairman Jerome Powell will hold a press conference half an hour later to explain related matters.

Tim Duy, Chief U.S. Economist at SGH Macro Advisors, believes that the current uncertainty may provide policymakers with more reasons to adopt a gradual rate-cutting strategy. He noted, "As we approach these estimated limits, it is reasonable for the Federal Reserve to take a more cautious approach when assessing its position in the policy cycle."

Figure 1

In terms of interest rate decisions, the market generally expects the Federal Reserve to lower the benchmark interest rate by a quarter of a percentage point, bringing the federal funds rate to a target range of 4.25% to 4.5%. However, this interest rate level is significantly higher than the 2.9% neutral rate level predicted by officials in September, indicating that policymakers are raising their estimates for this rate. This is also one of the reasons some policymakers prefer to reduce the magnitude of rate cuts.

Regarding economic forecasts, data from recent months indicate that the economy is performing better than officials expected when they last released their forecasts. Therefore, policymakers may raise their economic outlook predictions, showing rising inflation rates, declining unemployment rates, and stronger economic growth.

The latest "dot plot" will show the expected path of interest rates, with officials expected to cut rates fewer times next year than predicted in September. However, these forecasts have not fully reflected the policy impacts of President-elect Trump, and Federal Reserve officials are waiting for more policy details. Some Federal Reserve officials have pointed out that they need to wait for more detailed information from the Trump administration regarding tariffs and deportation policies to incorporate these policy factors into their economic growth and inflation forecasting models.

According to a Bloomberg survey, most economists predict that officials will implement three rate cuts next year, which is one less than the prediction made by policymakers in September.

Anna Wong, Chief U.S. Economist at Bloomberg, commented, "Given that the core PCE inflation data for November is expected to show weakness—although this data will be officially released on December 20, the Federal Reserve staff has been able to make highly accurate estimates based on CPI and PPI data—this may have prompted some Federal Reserve officials who were originally concerned about inflationary risks to change their minds and reluctantly accept the decision to cut rates again." In terms of statements, Federal Reserve officials may retain a statement similar to that of November, indicating that the risks to achieving employment and inflation targets are "roughly balanced." However, there may also be some wording added to suggest that they expect to "gradually" lower interest rates or hint at a possible pause in rate cuts in the near future. Economists at Barclays believe that after a rate cut this week, the Federal Reserve may keep rates unchanged in January and convey this message through relevant wording.

At the press conference, Federal Reserve Chairman Jerome Powell may elaborate on how officials interpret economic data and its impact on policy. He may be asked when the rate cuts will pause and whether this pause will come in January.

Investors will closely monitor any insights from officials regarding future policy steps. Additionally, Powell may face questions about whether the central bank's progress toward achieving its inflation target has stalled and whether the current employment outlook is more optimistic.

Focus on the 2025 Action Path

Currently, investors widely expect the Federal Reserve to make its final rate cut this Wednesday, but the market is more concerned about whether the Federal Reserve will adjust its policy action expectations for 2025. All eyes will be on the Federal Reserve's "dot plot," a chart updated quarterly that shows each Federal Reserve official's forecast for the federal funds rate trajectory. With a series of unstable inflation data and cautious statements from Federal Reserve officials, the policy forecast for 2025 is under scrutiny. Meanwhile, new policies from the Trump administration may pose additional challenges for central bank decision-makers.

In September, the Federal Reserve made its first rate cut in over four years. At that time, the dot plot indicated a consensus among Federal Reserve officials that there would be two more rate cuts in 2024 and four smaller additional cuts in 2025. However, the current economic situation has changed significantly.

Former Cleveland Federal Reserve Bank President Loretta Mester stated that the previous prediction of four rate cuts next year needs to be "reconsidered," forecasting that the economy will "slow down" in 2025. She believes that two to three rate cuts in 2025 is reasonable.

However, Wilmington Trust Chief Economist Luke Tilly holds a different view, arguing that Federal Reserve officials will stick to their prediction of four rate cuts in 2025, as overall inflation is expected to decline.

Federal Reserve Chairman Jerome Powell left room for necessary policy adjustments in early December, noting that "we can be more cautious" given that economic performance in early autumn was stronger than expected. However, some economists were surprised by two unexpected developments at the end of 2024, which could lead to a downward revision of expectations.

First, the labor market has not shown any new signs of weakness. Second, inflation data in the autumn remains stubbornly stagnant, failing to approach the Federal Reserve's 2% target.

Figure 2

The latest evidence comes from inflation data released last week by the U.S. Bureau of Labor Statistics, showing that the Consumer Price Index (CPI) rose 2.7% year-on-year in November, slightly higher than October's 2.6%. Meanwhile, the "core" CPI, which excludes food and energy price fluctuations, rose 3.3% year-on-year in November for the fourth consecutive month, and the unexpected increase in wholesale prices in November exceeded market expectations Further exacerbated inflationary pressures. These data further raised market expectations for the Federal Reserve to cut interest rates this week, increasing the probability to over 95%.

Figure 3

Divergence in Officials' Views, Inflation and Employment as Focus

Regarding whether the Federal Reserve will adjust its economic forecasts for 2025, some hold a reserved attitude. Tilly from Wilmington Trust is one of them, believing that after the dot plot is released on Wednesday, the median interest rate forecast range for the end of 2025 will remain between 3.25% and 3.5%.

Tilly pointed out that while Federal Reserve officials acknowledge that recent inflation data remains high, they also need to closely monitor the dynamics of the labor market. Despite significant market volatility, there is an overall trend of slowing down. Compared to most members within the Federal Reserve, Tilly is more concerned about the employment market. He believes that due to a weak labor market, the risk of economic recession is as high as 35%.

Tilly further emphasized that labor demand is gradually declining, and private sector job growth is currently below the average level of the past six months, at only 108,000 jobs. He predicts that the growth rate of the labor market will further slow down to nearly 100,000 new jobs per month in the future.

Similarly, Wilmington Trust's bond portfolio manager Wilmer Stith, as an observer of the Federal Reserve, holds a different view. He believes that the Federal Reserve may still implement four rate cuts next year.

Stith expects that at Wednesday's meeting, Powell will indicate that the Federal Reserve is making positive progress in controlling inflation and will point out that housing prices and other components of the CPI are moving towards the target. He emphasized, "This is undoubtedly a positive signal that 'we are getting closer to our goal.'"

As for the measures at Wednesday's meeting, Stith stated, "I think a 25 basis point cut is almost a done deal."

In addition, some Federal Reserve officials expressed optimistic expectations for the inflation outlook. Richmond Fed President Tom Barkin predicted in mid-November that inflation rates would continue to decline next year.

Barkin attributed the stable performance of recent core inflation data to a more stringent comparison base compared to last year. He expects that due to high inflation data in the first quarter of this year, the inflation data for the first quarter of 2025 may be more optimistic, a change that once prompted officials to reassess the inflation situation.

Similarly, Chicago Fed President Austan Goolsbee also called for a broader perspective in a speech in early December. He pointed out that since the inflation rate peaked at 9% in 2022, it has significantly decreased, marking a new high since 1981. Goolsbee added, "I still firmly believe that we will be able to achieve the 2% inflation target."

However, Cleveland Fed President Mester expressed a different view in an interview. She believes that the latest data, including last week's CPI, is sufficient to prompt Federal Reserve officials to reassess the policy path for 2025 Mester stated, "I believe people need to reconsider the appropriate policy direction for next year, even without considering the uncertain fiscal policy actions in the future, but we know these actions will happen sooner or later."

She further pointed out that although a rate cut is still possible this week, as it is what the market expects, a pause in rate cuts may occur in January. Mester believes, "They are more likely to complete the rate cut operations in December and then plan for next year's policies."