What are the prospects for the Federal Reserve to cut interest rates in 2025? Trump's policies still impose significant uncertainty

According to the Zhitong Finance APP, the Federal Reserve may need to see the impact of a series of economic policies from President-elect Donald Trump, including import tariffs, before it can raise its forecasts for inflation and interest rate changes in the first half of next year.

Despite raising its recent inflation expectations and citing the new administration's "highly conditional estimates of the economic impact of policies," the Federal Reserve last week lowered the benchmark federal funds rate to 4.375%, marking the third consecutive rate cut.

Considering the new economic realities, which may include massive spending cuts, significant changes to immigration policies, and a series of tariffs on imported goods, the Federal Reserve also halved its rate cut expectations for 2025, with the market currently anticipating only two rate cuts in the next 12 months.

Federal Reserve Chairman Jerome Powell told reporters last week, "The slowdown in the pace of rate cuts next year does reflect the higher inflation data this year and the expectation that inflation will rise."

He stated, "I think our actual cuts next year will not be because of anything we are marking down today. We will respond to the data; this is just the overall feeling that the Federal Open Market Committee thinks might be appropriate."

Uncertainty Related to Trump's Tariff Plans

However, this response may take time to evolve, as the President-elect may not be able to impose the tariffs he mentioned, and the reactions from U.S. trading partners have not been fully communicated.

Current legislation allows the president to impose targeted tariffs based on national security risks, but comprehensive taxation must be approved by Congress.

According to the Pew Research Center, the Republican Party holds only five majority seats in the upcoming House of Representatives, the fewest in modern history, and may lose three of those seats in special elections in the first half of the year.

Meanwhile, imposing tariffs on goods from Mexico and Canada may violate the trade agreement that Trump himself negotiated in 2020 and could face lengthy legal hurdles.

The same uncertainty applies to spending, as the President-elect has proposed numerous unfunded tax cuts, and just last week, he failed to successfully pressure Congress to extend or eliminate the debt ceiling.

Patrick Welton, founder and Chief Investment Officer of Welton Investment Partners, stated, "Investors should expect swift implementation of tariffs, slight cuts in government spending, and widespread tax policy delays in the first quarter of next year."

"But are tariffs long-term, or just something brought to the negotiating table?" he added.

Trump's tax and spending plans also face similar uncertainties.

Congressional Spending Debate

House members have passed a temporary budget agreement despite the President-elect's remarks. They must balance pressure from external agents, such as Elon Musk, whose task is to identify billions of dollars in spending from the federal budget, with the political need to fulfill campaign promises.

Samuel Tombs of Pantheon Macroeconomics stated, "(Last week) 34 House Republicans rejected a streamlined appropriations bill—even after the two-year suspension of the debt ceiling was lifted—indicating that Trump will have a hard time finding enough support next year." "To support a tax cut plan without spending cuts."

He added, "A fiscally neutral plan that funds tax cuts by reducing federal employment and cutting benefit payments will hurt consumer demand."

A slowdown in consumer demand, coupled with the inflationary impact of tariffs, could not only disrupt the current growth trajectory of the world's largest economy but also prevent the Federal Reserve from taking decisive interest rate actions for a long time in the second half of next year.

Currently, the CME Group's FedWatch tool indicates that the likelihood of a Fed rate cut in May is as likely as a coin toss, with the probability of a rate cut in June being only slightly higher.

Meanwhile, U.S. Treasury yields continue to rise, with the 2-year Treasury yield at 4.321%, just below the current federal funds rate, despite last week's inflation data for November coming in below expectations.

Is the Fed leaning dovish on interest rates?

Gregory Daco, chief economist at EY, stated, "Contrary to Powell's previous statements, the Fed 'does not guess, does not speculate, and does not assume' specific policy developments. The inflation forecast for 2025 is stronger, while the GDP and unemployment rate forecasts have not changed accordingly, indicating that some policymakers are indeed considering potential changes in regulation, immigration, trade, and tax policies."

That said, Daco noted that a more moderate outlook may emerge when the Fed reassesses its interest rate forecasts in the spring.

He said, "Although economic uncertainty has risen unusually, we emphasize that the consensus for strong growth and high inflation in early 2025 seems questionable." "Given the high dependence on data, it would not be surprising if the Fed's rate cut expectations are adjusted upward in three months."