US Fed has revised its Outlook from Three to Two Rate Cuts for 2025

The Federal Reserve cut rates by 25 basis points in its December 2024 meeting, bringing the federal funds rate to a target range of 4.25% to 4.5%. They signaled a slower pace for further rate cuts in 2025, expecting only two rate cuts, which would total a 50-basis point decrease for the year. This is a reduction from their previous projections of four rate cuts in 2025. This adjustment reflects concerns about inflation remaining elevated and the potential impact of incoming economic policies under a new administration.

The Fed has been engaged in quantitative tightening (QT), reducing its balance sheet by not reinvesting all proceeds from maturing securities. There’s an expectation that QT might conclude in 2024 or early 2025, moving to a point where reserves are considered “ample” but not “abundant.” The decision to end QT will be based on when changes in reserve levels start affecting short-term interest rates more significantly.

The U.S. Federal Reserve has not indicated plans for zero rate cuts in 2025; rather, the latest information suggests a more cautious approach to rate reductions. According to recent updates and projections:

The Fed has revised its outlook from three to two rate cuts for 2025, alongside an increase in expected inflation to 2.5% from 2.1%. This indicates a more hawkish stance compared to earlier forecasts. Therefore, while the Federal Reserve is planning fewer rate cuts than previously expected the notion of “zero rate cuts” for 2025 does not align with the available information. They are still anticipating some level of rate adjustment to manage economic conditions.

Inflation expectations for 2025 vary among different sources, reflecting a range of economic scenarios and policy impacts:

Federal Reserve Projections: The Federal Reserve has updated its projections, now expecting core PCE inflation to be at 2.5% for 2025, an increase from the previous forecast of 2.1%. This adjustment reflects concerns about potential inflationary pressures from policy changes, including those anticipated under the incoming Trump administration.

Market Expectations: Prediction markets are currently signaling higher inflation expectations for 2025, with some forecasts suggesting inflation could rise as high as 4.1%. This shift from earlier expectations of a peak at 3.6% indicates a growing concern about inflation reaccelerating.

The Federal Reserve is set to review its “Statement on Longer-Run Goals and Monetary Policy Strategy” in 2025. This review will assess the effectiveness of the current framework, particularly in light of recent economic challenges like supply chain disruptions and geopolitical tensions, potentially leading to updates or adjustments in its approach to achieve its dual mandate of maximum employment and price stability.

There’s discussion around potential challenges to the Federal Reserve’s independence, especially with the incoming administration’s historical views on monetary policy. This could impact how monetary policy is conducted, particularly with respect to the Fed’s response to inflation and employment.

Consumer Expectations: The University of Michigan’s survey shows 5–10-year inflation expectations at 3.3%, the highest since June 2008, suggesting that consumers might be anticipating more persistent inflationary pressures. Financial markets have adjusted expectations, with less hope for aggressive rate cuts in 2025, influencing investment strategies and market volatility, particularly in bond markets where yields are sensitive to Fed policy.

Professional Forecasters: According to the Blue-Chip survey, professional forecasters expect CPI inflation to cool slightly to 2.4% in 2025. This consensus outlook is more optimistic than some market and consumer expectations, highlighting a range of views on future inflation.

Economic Outlooks: Various economic forecasts from institutions like Goldman Sachs, Vanguard, and the Congressional Budget Office (CBO) offer a range of inflation expectations for 2025, generally between 2.2% and 2.5%, influenced by factors like tariff policies, immigration changes, and labor market conditions. These policy changes and considerations reflect a nuanced approach by the Federal Reserve to navigate economic uncertainties, balance inflation control with employment goals, and maintain credibility in the face of potential political pressures.

International Perspectives: For countries outside the U.S., like Belgium, inflation is expected to fall below 2% in 2025, indicating a divergence in global inflation expectations. Overall, inflation expectations for 2025 in the U.S. appear to be holding at elevated levels compared to the Federal Reserve’s long-term target of 2%, with a variety of factors contributing to these expectations, including policy uncertainty and consumer sentiment.