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Recently, the Federal Reserve’s trajectory appeared clear: with a decrease in inflation and a slowdown in the job market, the Fed was ready to gradually reduce interest rates. In September, officials projected the possibility of cutting their benchmark rate four times in the upcoming year, following three rate cuts already made this year. However, the situation has rapidly evolved.
Unexpectedly robust economic data, alongside policy proposals from President-elect Donald Trump, have prompted the Fed to adopt a more cautious stance. This shift could imply fewer rate reductions and potentially elevated interest rates than previously anticipated.
If the Fed implements fewer rate cuts, high mortgage rates and other borrowing costs are likely to persist for both consumers and businesses. Consequently, auto loans could remain costly, and smaller firms might continue to grapple with elevated loan rates.
During a recent address in Dallas, Chair Jerome Powell emphasized that the Fed is not inclined to reduce rates at every six-week meeting. “The economy is not sending any signals that we need to be in a hurry to lower rates,” Powell stated. He noted that the current economic strength allows for a more measured approach in decision-making.
His remarks were interpreted as an indication of fewer anticipated rate cuts in 2025, contributing to a decline in stock prices that had surged following Trump’s election. Trump’s proposed policies, particularly higher tariffs on imports and mass deportations of undocumented immigrants, have raised concerns among economists that inflation could worsen. His agenda also includes tax cuts and deregulation, which might stimulate economic growth but risk increasing inflation if businesses struggle to meet heightened consumer demand.
Recent economic indicators suggest that inflationary pressures could be more enduring and economic growth more robust than earlier projections indicated. In his latest press briefing, Powell mentioned the possibility of economic acceleration in 2025.
In light of these developments, Wall Street traders and some economists now foresee only two rate cuts next year instead of the previously predicted four. While a cut to the key rate is likely during the Fed’s mid-December meeting, traders also see a substantial chance that the central bank may opt to keep rates steady.
Jim Baird, the chief investment officer at Plante Moran Financial Advisors, noted, “I absolutely would anticipate that they’ll ease up on the pace of cuts.” He suggested that the expectation of continued economic growth raises questions about the necessity or ability of the Fed to cut rates at the previously indicated pace.
Bank of America economists predict that inflation will likely hover above 2.5%, exceeding the Fed’s target of 2%, partly due to the anticipated inflationary impacts of Trump’s economic initiatives. They now anticipate only three rate reductions over the coming months, scheduled for December, March, and June. Furthermore, they project that the Fed will cease easing credit once the benchmark rate, currently at 4.6%, drops to 3.9%.
Krishna Guha, an analyst at Evercore ISI, noted that the Trump presidency seems to influence a shift towards a more cautious Fed, particularly regarding the pace and extent of potential rate cuts. Trump’s commitment to imposing a 60% tariff on Chinese goods and a universal tariff of 10% or 20% on other imports has elicited warnings from retail executives, including Walmart’s CFO, about the inflationary effects that could arise from such tariffs.
In navigating the appropriate interest rate levels, Fed policymakers face a challenging dilemma. They are uncertain how far they can lower rates before reaching what is termed the “neutral rate”—a level that neither stimulates nor contracts the economy. The goal is to avoid setting rates low enough to rekindle inflation or keeping them so high that it jeopardizes job growth or triggers a recession.
A significant variance in opinions has emerged among the 19 officials on the Federal Reserve’s rate-setting committee regarding the position of the neutral rate. In September, they estimated it to be between 2.4% and 3.8%, a range much broader than two years ago. Lorie Logan, president of the Federal Reserve Bank of Dallas, remarked that the current benchmark rate might now sit slightly above this neutral level, suggesting minimal need for additional cuts.
Conversely, other officials, like Austan Goolsbee of the Chicago Fed, view the neutral rate as considerably lower than the current rate, indicating that further cuts might still be warranted. “I still think we’re far from what anybody thinks is neutral,” Goolsbee remarked, emphasizing that more rate reductions could be needed.
The uncertainty surrounding Trump’s economic proposals—particularly concerning tariffs, immigration, and tax reductions—poses a significant challenge in shaping the Fed’s rate strategy. While Powell has stated that any changes in Fed policies will hinge on the actualization of these proposals, he refrained from offering specific comments on presidential agendas.
He did, however, mention that Fed economists are currently analyzing the potential impacts of a Trump administration on the economy. “We don’t actually really know what policies will be put in place,” Powell commented, “We don’t know over what timeframe.”
Another complicating factor is that the economy today is markedly different from when Trump was initially inaugurated in January 2017. With unemployment now lower, economists warn that additional stimulus through tax cuts could generate more demand than the economy can handle, potentially fueling inflation.
Olivier Blanchard, a former chief economist at the International Monetary Fund, recently pointed out that tax cuts in an economy nearing full employment might lead to inflation, thereby necessitating higher Fed policy rates and a stronger dollar.
Back in 2018, when Trump implemented various tariffs on Chinese goods and other imports, Fed economists assessed the optimal response. They concluded that as long as the tariffs were seen as one-time changes and public inflation expectations remained low, an increase in the Fed’s key rate wasn’t necessary. However, last week Powell acknowledged that today’s economic landscape is different, with inflation posing a greater risk. “Six years ago,” he noted, “inflation was really low and inflation expectations were low. And now, we’ve come way back down, but we’re not back where we were. It’s a different situation.”
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