In September 2024, the Federal Reserve finally started to cut rates after seeing lower inflation, strong labor markets and economic stregnth. The expectations at that point was for the Fed to cut rates 2 more times in 2024 and at least 4 more times in 2025. (1)
In November 2024, Trump was declared the winner of the presidential election and economists and Fed officials began to consider what impact policies around taxes, tarriffs and immigration would have on the economy. Going into the December FOMC meeting the expectation was for fed to cut rates 25bps, but the market was on edge as to whether the Fed plans to make further cuts in 2025. Could these new policies in the new year stoke or reignite inflation? (2)
Bob Michael, JPM head of fixed income
“The rest of the world is struggling with lower growth, they don’t have stimulus, they are struggling with higher prices…” (3)
Tom Keene injects “This is ‘american exceptianalism'”
This ‘American Exceptianalism” is a challenge for the Fed, is even if they cut rates, markets do not necessarily follow in lock step. In September when the Fed started their rate cutting cycle 10 yr bond yields were 3.7%; in December after 75 bps in rate cuts the 10 yr yield is 4.3%.
Ellen Zentner, Morgan Stanley economist
“The Fed is in a tough spot; growth has been stronger, inflation has been stickier, and unemployment is lower… roll your magic eight ball…”
Tom Keene jokes, “Do you use one?”
Zentner, a top ranked economist on Wall St smiles and jests, “A magic eight ball? I do, that’s how our record has been so good.”
She contiues, “The reality is many people are struggling, but ‘the haves of america’ are supporting the economy; the wealthy are propping up consumer demand disproportionatly, and that is likely to continue.”
Lisa Abramowicz asks, “Are financial conditions tight enough that the Fed needs to cut rates?”
Zentner points to the continuing stregnth of the US economy and says, “I don’t think you can say that looking at the economy. When they cut today and we get into January, really how much looser can you make it (without stoking inflation)?”
When asked where interest rates should be (or what the neutral rate is) Bob Michael states, “Before November the neutral rate was 3%, now with stimulus, tarriffs, immgration pending the neutral rate is 4%.”
Jon Ferro asks, “The election changed that much?”
“100%” says Bob Michael.
At 2pm the Fed announced its decision and guidance for 2025, and it moved markets…
As expected the Fed cut 25bp, but they also lowered the projection for the number of rate cuts expected in 2025 from 4 cuts to 2 cuts.
There was one dissent on the decision to cut rates who wanted no cut in December; It is also worth noting that 3 non voting FOMC members would have dissented as well. Some of those members become voting members on the FOMC in 2025.
The Fed revised its inflation forcast higher for 2025, up to 2.5% from 2.1% in October. This is a dramatic shift.
Regarding future decisions, the Fed commited to assess data regarding extent and timing of future moves to cut or raise rates.
Lisa Abramowicz stated, “This is the definition of a hawkish cut.”
During his press conference following the release, Powell was asked, “Why should the Fed cut rates in 2025 if inflation is projected to be higher?”
Powell responded, “We have made a great deal of progress on inflation; I think the slower pace of cuts reflects the expectation that inflation will be higher, but we see ourselves on track and will react to data.”
When asked what exactly would motivate the Fed to cut further, he said “We would be looking for stregnth in the labor market and lower inflation; that can allow more rate cuts.”
Later in the conferance Powell noted, “Inflation in the past few months has significantly underperformed; we need to see inflation come down more.”
Following the release and news conference, the 2 yr yield moved up 10bp. The dollar rallied 1% higher, the euro, yen and emerging market currencies fell dramaticly.
Powell was asked by Michael McKee, “Do you have confidence in your inflation projection?”
Powell said, “We’ve made a great deal of progress, we do have confidence, inflation will steadily come down… it might take another year or two from here.”
Markets reacted to this information negatively.
Equity markets ended the day 3-5% lower, the worst day since 2001. Bond yields rose and bond prices fell.
After a decade of low inflation following the Great Financial Crisis of 2008, inflation seems to be entrenched because of a variety of factors; rising wages, supply chain disruptions, higher commodity prices. Another driver of inflation is the climate crisis… Powell sited the huricane damage in North Carolina affecting lumber and car prices, as well as higher egg prices being driven by the Avian Flu outbreak.
Managing risk going forward requires an awareness and appreciation for what is happening not just in the economy, or Washington DC, but the planet. If you would like to discuss how this analysis affects your investments and savings, reach out to me at james.cox@glic.com .
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