Fed cuts rates but Wall Street rattled by change to 2025 outlook

The US Federal Reserve cut interest rates and signalled it will slow the pace at which borrowing costs fall any further given a relatively stable unemployment rate and little recent improvement in inflation.

“Economic activity has continued to expand at a solid pace” with an unemployment rate that “remains low” and inflation that “remains somewhat elevated,” the central bank’s rate-setting Federal Open Market Committee said in its latest policy statement.

Federal Reserve chair Jerome Powell will speak at 6.30am AEDT.Credit: AP

“In considering the extent and timing of additional adjustments to the target range ... the committee will carefully assess incoming data, the evolving outlook, and the balance of risks,” it said in new language that sets up a likely pause to rate cuts beginning at the January 28-29 meeting.

US central bankers now project they will make just two quarter-percentage-point rate reductions by the end of 2025. Wall Street’s indexes tumbled on the updated outlook for 2025, sinking to their second-worst loss of the year.

The S&P 500 dropped 2.9 per cent to pull further from its all-time high set a couple of weeks ago. The Dow Jones sank 2.6 per cent, or more than 1100 points, and the Nasdaq composite dropped 3.6 per cent.

Speaking at a press conference after the end of the central bank’s two-day policy meeting, Fed chair Jerome Powell described the latest rate cut as a “closer call” and noted that the slower pace of projected rate cuts next year reflected higher inflation readings in 2024.

“From this point forward it’s appropriate to move forward cautiously and look for progress on inflation ... from now we are in place where the risks are in balance.”

That is half a percentage point less in policy easing next year than officials anticipated as of September, with Fed projections of inflation for the first year of the new Trump administration jumping from 2.1 per cent in their prior projections to 2.5 per cent in the current ones – well above the central bank’s 2 per cent target.

Slower progress on inflation, which is not seen returning to the 2 per cent target until 2027, translates into a slower pace of rate cuts and a slightly higher ending point of 3.1 per cent, also hit in 2027, versus the prior “terminal” rate of 2.9 per cent seen as of September.

Fed officials also boosted their estimate of the long-run neutral rate of interest to 3 per cent.

The reduction in the benchmark policy rate to the 4.25 per cent-4.50 per cent range was opposed by Cleveland Fed President Beth Hammack, who preferred to leave the policy rate unchanged.

Powell also said that the US central bank has no desire to be involved in any government effort to hold large amounts of bitcoin.

“We’re not allowed to own bitcoin,” Powell said at a press conference following the latest Federal Open Market Committee meeting, where policymakers cut rates as expected while signaling a less certain path for monetary policy in the months ahead.

In terms of the legal issues around holding bitcoin, “that’s the kind of thing for Congress to consider, but we are not looking for a law change at the Fed,” Powell said.

Trump uncertainty

The new policy rate is now a percentage point lower than the peak reached in September when officials concluded inflation was dependably on the way back to the 2 per cent target and that there were risks to the job market of keeping monetary policy too tight for too long.

Donald Trump’s election win has introduced more uncertainty into the economic outlook. Credit: AP

Key measures of inflation since then, however, have largely moved sideways, while continued low unemployment and stronger-than-expected economic growth have sparked debate among policymakers about whether monetary policy is as tight as thought – a discussion reflected in the steady increase in the long-run estimate of the neutral rate over the past year from 2.5 per cent to 3.0 per cent.

The Fed, which hiked rates aggressively in 2022 and 2023 to combat a surge in inflation, began its easing cycle in September with a half-percentage-point cut in borrowing costs. It lowered rates by a quarter of a percentage point last month.

The latest quarterly projections are the first since President-elect Trump’s victory in the November 5 election, which introduced a new level of uncertainty into the economic outlook given his campaign promises for tax cuts, tariff hikes, and a crackdown on unauthorised immigration – aspects of which some analysts see as inflationary.

Trump doesn’t take office until January 20, and Fed officials have said they can’t base monetary policy on campaign proposals that may or may not be enacted.

Still, Fed staff have likely been gaming out different scenarios, and policymakers’ projections show growth remaining above potential at 2.1 per cent next year, inflation remaining above target for two more years, and the jobless rate never rising above 4.3 per cent.

“While the Fed opted to round out the year with a third consecutive cut, its New Year’s resolution appears to be for a more gradual pace of easing,” said Whitney Watson, global co-head and co-chief investment officer of fixed income and liquidity solutions for Goldman Sachs Asset Management. Watson added that “we expect the Fed to opt to skip a January rate cut, before resuming its easing cycle in March.”

Reuters

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