As was widely expected, the Federal Reserve maintained the federal-funds rate at its current range of 4.25%-4.50% at its January meeting. This is the first time the Fed has done so since it initiated cutting in September 2024. The central bank has cut by a total of 1 percentage point since then. Before September 2024, the rate had been on a plateau of 5.25%-5.50% since July 2023. The next steps hinge on incoming data, and whether large tariff hikes are pushed through.
Fed Chair Jerome Powell stated that the US economy is “set up for further progress on inflation.” The central bank tends to pay the most attention to the year-over-year growth rate in core PCE prices. This stood at 2.8% as of November 2024. But if the first quarter of 2025 doesn’t see a repeat of the large price increases in the first quarter of 2024, core PCE inflation should drop to 2.4% year over year or lower by March.
A key question is how much further the Fed will seek to cut rates once inflation has converged to the 2% target. That is tantamount to asking what the neutral interest rate is—the rate that generates a balanced level of economic growth in the long run. Powell said virtually everyone agrees the neutral rate is below the current one, but he was vague beyond that, acknowledging wide uncertainty in estimates.
Ultimately, the Fed will lean heavily on incoming data on economic activity and the labor market to assess how much easing will be appropriate. For now, the labor market isn’t providing a strong reason to cut rates aggressively. The unemployment rate (three-month average) has held steady at around 4.15% in the past several months. That has eroded earlier fears that the labor market was deteriorating. The unemployment rate had drifted up from a three-month average of 3.6% as of August 2023 to 4.2% in August 2024, triggering the “Sahm rule” recession indicator.
Accordingly, in today’s official statement, the prior reference to “eased” labor market conditions was stricken, replaced with the remark that “labor market conditions remain solid.”
When Will the Fed Cut Rates?
Part of Powell’s reticence on the Fed’s path forward stems from the high degree of policy uncertainty. Most importantly, potential tariff hikes could throw a wrench in bringing inflation back to normal. As Powell stated, the “range of possibilities is very, very wide.”
All told, this was not a very informative event. The FOMC’s projections haven’t been updated, and Powell was relatively taciturn in the press conference. Accordingly, markets didn’t react much, with the 2-year US Treasury yield increasing by just 2 basis points. The futures market-implied probability of a rate cut for March shifted slightly to about 20% today from 30% yesterday. Markets are still expecting a year-end 2025 federal-funds rate of 3.75%-4.00%, unchanged from yesterday.
Federal-Funds Rate Target Expectations for March 19, 2025 Meeting
Source: CME FedWatch Tool.
We continue to expect more rate cuts than the market, with our year-end 2025 federal-funds rate expectation at 3.25%-3.50% (four rate cuts versus the market’s two). Furthermore, we expect the federal-funds rate to drop further to 2.25%-2.50% by early 2027, whereas the market expects rates to hold steady indefinitely after reaching the target range of 3.75%-4.00%. We believe rates are still highly restrictive, which is likely to manifest in slowing GDP growth and a cooling labor market over the next one or two years.
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