"The Federal Reserve’s policies are like a game of Jenga—move too quickly, and the whole structure wobbles."
The Federal Reserve’s December meeting delivered what markets largely expected: a 25-basis-point rate cut alongside a tempered forecast for future reductions. But buried in the details of Chair Jerome Powell’s statements and the Fed’s updated projections is a message of cautious optimism balanced by economic pragmatism. Claire Fan of RBC Economics sums it up: “The Fed cut rates by 25 basis points as widely expected, but also signaled a more gradual easing cycle going forward alongside upwardly revised growth and inflation forecasts.”
Let’s unravel the Fed’s latest moves and explore the fine line it’s walking between inflation control and economic resilience.
The Hawkish Pivot: Gradual Easing with a Watchful Eye
The Fed’s policy statement remained largely unchanged from its November meeting, save for a notable new phrase: “The extent and timing of additional adjustments will depend on incoming data.” Powell later clarified this in his press conference, signaling that the Fed is nearing a pause. “We are at or near a point at which it will be appropriate to slow the pace of further adjustments,” Powell explained—a sentiment RBC shares, with Fan predicting just “one more cut in January” before the Fed holds steady at a 4% to 4.25% range for 2025.
Behind this cautious approach are modest revisions to the Fed’s macroeconomic outlook:
- GDP Growth: Revised up to 2.1% for 2025, indicating a U.S. economy that remains more resilient than anticipated.
- Unemployment Rate: Lowered to 4.3%, reflecting ongoing labor market strength.
- Core PCE Inflation: Adjusted higher to 2.5% in 2025, from the previous forecast of 2.2%.
These adjustments underscore why Powell remains adamant about keeping rates at restrictive levels. As he noted, “Interest rates likely need to remain at restrictive levels to keep inflation on a downward trajectory.”
The Dot Plot Thickens: Fewer Cuts, Higher Neutral Rates
Perhaps the most striking revelation came from the dot plot, which mapped out a slower pace of rate cuts. The median projection for the federal funds rate at the end of 2025 is now 3.9%, up from 3.4% in September. This implies just two more 25-bps cuts next year. In 2026, the Fed expects rates to decline by another 50 bps, landing at 3.4%—a far cry from the rapid easing cycles of the past.
Adding another layer of complexity, the Fed nudged its long-term estimate of the “neutral” interest rate—the rate neither restrictive nor stimulative—from 2.9% to 3%, signaling a world where monetary policy must adapt to structurally higher rates.
Inflation: Old Ghosts, New Pressures
Inflation remains the elephant in the room. While headline CPI growth for goods and services excluding food, energy, and rent has picked up in recent months, Powell dismissed these increases as residual noise from the inflationary surges of 2021 and 2022. “Inflation should be on the expected course lower,” he reassured, highlighting the gradual cooling in labor markets, which no longer appear to be a key source of inflation.
Yet Powell’s confidence in disinflation hinges on restrictive rates. Mortgage costs, rental inflation, and persistent wage growth all act as wildcards, keeping the Fed on edge.
Labor Markets: Cool but Not Cold
The Fed faces a delicate balancing act when it comes to labor markets. While the unemployment rate has risen to 4.3%, Powell emphasized the need to avoid “further softening” in labor markets, signaling that policymakers are not looking to push joblessness to unsustainable levels to achieve their inflation goals. As Claire Fan notes, “Labour markets will continue to normalize but not crumble.” This nuanced stance ensures that rate cuts will come slowly, with economic stability prioritized over rapid inflation suppression.
Tariff Troubles: A Cloud of Uncertainty
Potential tariffs loom large in the background, but Powell offered little insight, referencing the “high levels of uncertainties” around how such policies might unfold. Much like the Bank of Canada, the Fed appears unwilling to speculate on the broader economic impact of potential trade disruptions. For now, it’s a wait-and-see game on how protectionist policies might ripple through supply chains and inflationary dynamics.
Key Takeaways
- One More Cut in January: The Fed is likely to deliver one final 25-bps cut in January before holding rates steady at 4% to 4.25% for the rest of 2025.
- Resilient Economy: Upward revisions to GDP growth (2.1%) and lower unemployment projections (4.3%) highlight a U.S. economy that’s weathering higher rates better than anticipated.
- Higher Neutral Rate: The Fed’s long-term neutral rate estimate rose slightly to 3%, signaling a structural shift toward a world of higher baseline interest rates.
- Gradual Inflation Path: Core PCE inflation is now expected to hit 2.5% in 2025, keeping restrictive monetary policy on the table longer than markets might like.
- Labor Market Sensitivity: Powell emphasized that while labor markets are cooling, further softening is not desirable, underscoring the need for a measured approach to rate cuts.
Conclusion: A Marathon, Not a Sprint
As the Fed prepares for a slower easing cycle, investors and consumers alike must grapple with a world of persistently higher interest rates. Powell’s stance is clear: the fight against inflation isn’t over, and the pace of monetary policy will remain deliberate. Claire Fan’s summation captures the delicate equilibrium best: “Rates will stay high for longer to offset [inflationary pressures].”
The Fed’s strategy is a calculated dance between optimism and caution, resilience and prudence. For those watching from the sidelines, patience remains the most valuable currency.
Every time you ♡ Like this piece, the Fed’s dot plot gets just a little easier to decipher.
Source: Claire Fan, RBC Economics, December 18, 2024. "https://view.website.rbc.com/?qs=b3518d763563e209cacff29acbfbeeae01cb9fbb4c93d2669c7ec1e2f402c8ff904a344966
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