Institutional Interpretation | Driving in Fog: The Federal Reserve Will Slow Down Rate Cuts
The Federal Reserve lowered interest rates by 25 basis points as scheduled in the December meeting, with policymakers' forecasts for the future economy and interest rates leaning hawkish. We believe the hawkish guidance is precautionary, as the Federal Reserve does not want to make another mistake regarding inflation. However, officials have not completely abandoned the idea of further rate cuts; today’s hawkish stance is to avoid being hawkish tomorrow. The Federal Reserve's guidance is consistent with our predictions in the annual report (please refer to "Overseas Macro 2025 Outlook: From Soft Landing to New Equilibrium"), thus we maintain our judgment that the policy rate will be lowered to a neutral level of 3.75%-4.0% in 2025. In terms of the pace of rate cuts, we predict that the Federal Reserve will "skip" the January meeting next year, followed by rate cuts of 25 basis points in the March and June meetings, and then halt further cuts, entering a wait-and-see mode in the second half of the year, with monetary policy decisions based on the effects of Trump's administration. We do not believe that the interest rate guidance provided by the Federal Reserve is overly tight, nor do we see signs that monetary policy is about to undermine the "soft landing" outlook. More uncertainty comes from Trump's policies, but that will only become clear after Trump takes office on January 20
Source: CICC Insights
The background of this meeting is that the U.S. economy and employment have remained resilient in recent months, inflation remains sticky, Donald Trump has won the 2024 U.S. presidential election, and future policy uncertainty has increased. The market had fully digested the expectation of a 25 basis point rate cut before the meeting, and investors are more focused on the path of Federal Reserve rate cuts in 2025.
The Federal Reserve cut rates as expected at this meeting while showing a "hawkish" stance. The hawkishness of the Federal Reserve is reflected in three aspects: First, in the latest forecast table, Federal Reserve officials significantly raised their forecast for economic growth in 2024 from 2.0% in September to 2.5%, and also raised their forecast for 2025 by 0.1 percentage points to 2.1%; they lowered their forecast for the unemployment rate, believing it will remain at 4.2% for the year, and that the unemployment rate will stabilize around 4.3% in 2025 and 2026; they raised their forecasts for inflation and core inflation, believing that PCE and core PCE will be around 2.5% in 2025, higher than the previous 2.2%.
Second, regarding the dot plot, among the 19 officials, 10 predict two or more rate cuts before the end of 2025, another 3 predict only one rate cut, and 1 predicts no further cuts[1]. This indicates that a majority of officials lean towards needing to continue cutting rates in 2025, but the number of cuts has been reduced from 4 in September to 2. The median rate forecast for the end of 2025 has been raised from 3.4% to 3.9%, and the median rate for the end of 2026 has been raised from 2.9% to 3.4%, with the long-term rate forecast median rising by 0.1 percentage points to 3.0%. This indicates that decision-makers believe the neutral rate is gradually rising.
Third, this 25 basis point rate cut was not a consensus among all. Among the 12 voting officials, 11 voted in favor, while Cleveland Fed President Beth Hammack voted against it, preferring to "skip" the rate cut at this meeting[2]. The dot plot also shows that among the 19 officials, 4 believe that a rate cut was unnecessary at this meeting. This indicates that there is growing resistance within the Federal Reserve to lowering rates.
Why is the Federal Reserve leaning hawkish? We believe it is for precautionary reasons; the Federal Reserve does not want to make another mistake on inflation. With Trump about to take office, the market is concerned that some of his policies (such as increasing tariffs, expelling immigrants, and tax cuts) could push inflation higher. Although there is still significant uncertainty regarding these policies, including which tariffs will be imposed, from which countries, the scale, whether there will be reciprocal measures, and the duration, the Federal Reserve still hopes to cautiously assess any potential inflation risks in the future.
In 2021, U.S. inflation rose, and the Federal Reserve believed it was temporary (transitory), but inflation further increased in 2022, forcing the Federal Reserve to continuously raise rates by 75 basis points. Now, although inflation risks have not yet emerged, the Federal Reserve has shown considerable caution, which is an instinctive reaction. Powell stated at the press conference that the decision to cut rates is like "driving in fog," and they are closer to their destination; when the U.S. economy is growing strongly, and both inflation risks and the target position for the neutral rate are uncertain, it is more appropriate to brake and slow down, cautiously observing the way forward But the Federal Reserve has not completely abandoned the idea of rate cuts; today’s "hawk" is to avoid being a "hawk" tomorrow. The latest dot plot shows that policymakers still expect two rate cuts in 2025. Powell stated that although the labor market has stabilized recently, various indicators show that it is cooling in an orderly manner compared to before, and the labor supply-demand ratio is more "loose" than before the pandemic, with both JOLTS hiring and turnover rates being lower. Under the influence of supply-side factors, the current new jobs are not sufficient to prevent the unemployment rate from rising further, and Federal Reserve officials do not want to see further slowdown in the labor market. The Federal Reserve believes that current interest rates remain restrictive, and if this helps inflation continue to make progress, then further rate cuts would be appropriate.
The Federal Reserve's guidance is completely consistent with our predictions in the annual report, and we maintain our judgment on the rate cut path for 2025. Previously, we predicted that the Federal Reserve would continue to cut rates in 2025, returning monetary policy to neutral, with the federal funds rate lowered to a neutral level of 3.75% to 4%, which is about 150 basis points higher than the neutral rate before the pandemic. We still maintain this judgment. In terms of the pace of rate cuts, we predict that the Federal Reserve will "skip" the January meeting next year, followed by a 25 basis point cut in the March and June meetings, and then stop cutting rates, entering a wait-and-see mode in the second half of the year, with monetary policy decisions based on the effects of Trump's administration (please refer to “Overseas Macro 2025 Outlook: From Soft Landing to New Equilibrium” and “US Inflation May Drive 'Hawkish Rate Cuts'”).
The market reacted strongly to the Federal Reserve's hawkish stance, with U.S. Treasury yields rising sharply, the dollar soaring, and the three major U.S. stock indices facing setbacks. We tend to believe that investors are "selling the fact," meaning they are taking profits after the rate cuts are realized. We do not believe that the interest rate guidance provided by the Federal Reserve is overly tight, nor do we see signs that monetary policy is about to undermine the "soft landing" outlook. We believe that more uncertainty comes from Trump's policies, but that will only become clear after Trump takes office on January 20th, a month from now.
Chart 1: Federal Reserve's December Interest Rate Dot Plot
Chart 2: Federal Reserve's Economic Indicator Forecast (December 2024)
Source: Federal Reserve, China International Capital Corporation Research Department
Chart 3: Comparison of Federal Reserve Monetary Policy Statements (December 2024 vs November 2024)
Source: Federal Reserve, China International Capital Corporation Research Department