Markets widely expect the Federal Reserve to cut rates for the third time this year at its December meeting. The question is what the central bank will do next year.
Recent persistent inflation data and evidence that the US economy is growing at a robust pace have raised doubts that the Fed will cut rates as quickly as previously indicated. In September, the Fed’s Summary of Economic Projections (SEP) predicted four rate cuts next year.
Read more: What the Fed’s interest rate cut means for bank accounts, CDs, loans and credit cards
According to Bloomberg data, markets are currently predicting roughly two cuts in 2025. The Fed is expected to release an updated forecast on December 18.
While they differ on the details, Wall Street economists generally agree that the current rapid pace of central bank rate cuts will not continue.
“As we head into 2025, we’re likely to see a slower pace of cuts going forward, with the Fed likely moving to a different pace,” said Wells Fargo senior economist Sarah House, whose team sees three rate cuts. in 2025, said during a media roundtable on November 21.
At a current range of 4.5% to 4.75%, there is little debate about whether the Fed Funds rate is restrictive. This has led many economists to believe that further easing is likely in the pipeline as the Fed continues to aim for a “soft landing” with inflation falling back to the 2% target without a significant downturn in the economy.
With the US economy growing at a strong pace and concerns about a slowdown in the labor market on the back burner for now, the sticking point in the debate is the extent to which the Fed will cut rates in the coming year without a significant improvement in inflation rates to see.
Deutsche Bank chief U.S. economist Matthew Luzzetti sees the Fed making another cut in December before pausing interest rate adjustments for all of 2025, pending more progress on inflation.
“There is much less urgency to cut rates,” Luzzetti told Yahoo Finance. “It could make sense to slow the pace of rate cuts sooner than expected.”
In recent months, inflation’s progress toward the Fed’s 2% target has “stalled,” Fed Governor Michelle Bowman said in a recent speech as she urged the central bank to proceed “with caution.” to deal with interest rate cuts.
The latest reading of the Federal Reserve’s favorite inflation gauge showed that price increases in October were flat from the previous month. On Wednesday, the core Personal Consumption Expenditures (PCE) index showed prices rose 2.8% in October from a year earlier, well above the Fed’s target.
This followed two other persistent inflation readings that added to the debate over how deeply the Fed will cut rates in 2025.
House said that if the decline in inflation slows, “it will become increasingly difficult to justify additional rate cuts.”
Fed officials discussed a similar outcome at their November meeting.
“Some participants noted that the Committee could pause the easing of policy rates and keep them at restrictive levels if inflation remained high,” the Fed minutes said.
Economists at both Morgan Stanley and JPMorgan see the Fed’s path similarly to that of House and Wells Fargo, which would leave the Fed funds rate in a range of 3.5% to 3.75% at the end of 2025.
“Given easing disinflation and declining employment risks, we think this means the Fed slows the austerity cycle to once a quarter until it pauses indefinitely after setting a target range of 3.0% at next September’s FOMC meeting. has reached 5-3.75%.” JPMorgan chief economist Michael Feroli wrote in his 2025 economic outlook.
Seth Carpenter, chief economist at Morgan Stanley, sees a similar scenario in which the Fed will cut to that same range in May and then suspend rate cuts until 2026, amid “signs of sticker inflation and general policy uncertainty.”
Greg Daco, chief economist at EY, told Yahoo Finance that the Fed will suspend interest rate cuts in part to ensure rates are not cut so far that interest rate policy becomes “expansive.” Given that the U.S. economy is currently considered on solid footing, too much help from rate cuts could revive concerns that a red-hot U.S. economy is keeping inflation stubborn.
‘They want to avoid a situation in which they collapse by relaxing too quickly [the neutral interest rate]’, and suddenly monetary policy is expansionary,’ Daco said. The neutral interest rate is the level at which interest rates are considered neither restrictive nor supportive of economic activity.
Federal Reserve Chairman Jerome Powell speaks during a press conference following a Federal Open Market Committee meeting in Washington on November 7, 2024 in Washington, DC (Kent Nishimura/Getty Images) ·Kent Nishimura via Getty Images
Many economists share Carpenter’s concerns about the “policy uncertainty” that will arrive in 2025 when the new Trump administration enters the Oval Office.
Deutsche Bank’s Luzzetti told Yahoo Finance that this uncertainty is different from the pandemic reopening changes that changed every economic data point and therefore challenged the overall economic outlook. This time, the murky prospects are specifically tied to the details of President-elect Donald Trump’s policies and the timing with which they are being implemented.
While the difference between what Trump said before gaining control of the White House and which policies actually come to fruition remains to be seen, the consensus views various versions of his tariff policies as supplementing inflation. And that could be a challenge for the Fed, which is already struggling with persistent price increases.
Taking into account the different policy measures, Deutsche Bank estimates that the US economy will grow at an annual rate of 2.5% in 2025, with the unemployment rate reaching 3.9% at the end of the year (up from 4.1% currently) and the Fed’s preferred inflation measure, “core” personal consumption expenditures (PCE), ending in 2025 at 2.6%.
“From the Fed’s perspective, you have stronger growth, a stronger labor market and higher inflation… So all of those things together had to have some kind of aggressive implication for the Fed’s prospects,” Luzzetti said.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
Correction: An earlier version of this article stated an incorrect number of interest rate cuts in 2024. We regret this error.
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