Both economists and the markets agree that the Fed will cut rates by 25 bps on Wednesday. Assuming no surprises there, the focus will be on what the FOMC signals for next year. There are some additional uncertainties about the forward rate path, which means the Fed’s guidance could rile up the markets.
So far, the data has behaved along the lines that economists and the Fed had projected. This is particularly the case for inflation, which was expected to tick up in the final quarter of the year. Now that it has, the consensus is that inflation will turn back downward in 2025. However, we won’t know if that’s the case until we get the data.
Waiting for Confirmation
Fed Chair Jerome Powell has been fairly consistent since the last meeting that the future is a bit uncertain, which makes it harder for the Fed to offer guidance. Among those uncertainties is the actual effects that future President Donald Trump’s fiscal policies will have. While it’s widely speculated that tariffs in particular will generate inflationary pressures, how fast those policies are implemented and in what conditions will have an important effect on the actual inflationary reading.
With the US economy seen in largely solid footing, the Fed wouldn’t be in any rush to cut rates unless there were worrying signs in the labor market. And there, too, is some ambivalence in the data. Last month’s NFP showed a strong number of jobs being taken up. But, it also showed increasing softness in the market with a minor rise in the unemployment rate and the underemployment rate. The Fed might opt to have a more cautious approach while waiting for a new batch of data that will be available before the next FOMC Rate meeting – which will take place a week after Trump is sworn in.
Setting Up Expectations
The dollar has been gaining ahead of the meeting, thanks to higher yields. This has weighed on commodities, with gold fluctuating around the implications of the inflation data. PPI figures last Thursday showed that wholesale inflation was higher than anticipated, suggesting that inflationary pressure could persist next year. That would keep yields elevated, particularly if the Fed sticks to its ambivalent stance going through the holidays.
Economists and the market expect there to be three more FOMC rate cuts next year, for a total of 75 bps. That compares to the 100 bps that would have been achieved in the second half of this year, a clear indication of a slowing of the pace. Where there is uncertainty is the timing of those cuts, which economists and the markets expecting the Fed to pause at the next meeting.
It All Comes Down to the Phrasing
The market reaction to the FOMC Rate meeting might have to wait until Powell’s post-rate presser, as investors try to figure out what the Fed will do in January. If it manages to communicate some degree of certainty about whether a pause is more likely than a cut, then the dollar could gain or slide accordingly.
But the more likely scenario is that Powell sticks to his ambivalent stance, which could leave the markets in limbo through the holidays. That would likely generate more volatility, as investors try to figure out whether inflation or jobs data will drive the next move.
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