Fed cuts rates by 25 bps in December, but 2025 may be slower

19 Dec 2024 , 11:48 AM

DOVISH FOR 2024, SLIGHTLY HAWKISH FOR 2025

Even as the US Federal Reserve cut rates by 25 basis points to the range of 4.25% to 4.50%, there was a word of caution coming from the Fed chair, Jerome Powell. The Fed has already cut rates by 100 bps since it started with a 50 bps rate cut in mid-September. It later cut by another 25 bps in November and has topped it with an additional 25 bps in December. By cutting rates by 100 bps in year 2024, the Fed has lived up to the promise it made in September. However, the message from the Fed statement is that with labour markets in balance and inflation sideways, it may go slow on rate cuts in 2025. The indication is that the Fed may restrict itself to just 2 rate cuts of 25 bps each in the whole of 2025. Not surprisingly, the US markets corrected, but that was largely along expected lines.

SIGNALS WE PICKED UP FROM THE DECEMBER FOMC STATEMENT

In the December 2024 policy, the Fed lived up to its promise of completing 100 bps in 2024, but has given a slightly more cautious stance for 2025. Here are key takeaways from the monetary policy statement late on December 18,  2024.

• Jerome Powell captured the mood with his words, “Today was a much closer call, but we decided it was the right call,” as the Fed went ahead and cut rates by another 25 bps on December 18, 2024 to the level of 4.25%-4.5%. This effectively takes the rates back to the level that they were at in 2022.
• However, the guidance was more cautious. The Fed indicated that it likely lower the rates only twice more in 2025. In the last few months, the consumer inflation and the PCE inflation have shown a tendency to either remain static or inch upwards. This limits the scope for another year of aggressive rate cuts by the Fed.
• In terms of key macros, the Fed indicated that the decision was driven by the fact that inflation was steadily above the target level of 2%, with economic growth being robust. Labour market pressure has also eased after unemployment scaled up to 4.3% in August. This was not consistent with an aggressively dovish guidance.
• Powell also underlined that with 100 bps of rate cut, the policy stance was significantly less restrictive that it was in the middle of 2024. It may be recollected that the Fed had held rates for more than a year since July 2023. According to the data, the neutral rate for the long term has been pegged higher by 10 bps from 2.9% to 3.0%.
• Interestingly, despite the cautious guidance, there was a vote for dissent from Beth Hammack, Cleveland Fed President, who preferred a status quo on rates. As recently as in September 2024, when the Fed had cut rates by 50 bps, Michelle Bowman had given a dissent vote, underlining that 25 bps would have been sufficient at that juncture.
• In his post-policy statement, Powell also underlined why the Fed had cut rates aggressively since September. Apart from the spike in unemployment, the higher rate in the US economy were starting to influence a wide spectrum of consumer debt such as auto loans, credit cards and mortgages. Now, that pressure will reduce.
• To be fair, the stance of the Fed has not change substantively, and only the pace of future rate cuts have been changed. As Goldman Sachs put it, the Fed has probably postponed the rate cuts to 2026 instead of 2025, but the fundamental policy direction remains towards cutting rates progressively in the next few years.
• The quarterly update to projections made some interesting macro shifts. GDP estimate for 2024 has been raised by 50 bps to 2.5%, while unemployment is pegged lower at 4.2% for the year. However, the Fed estimates have pegged the core and headline inflation higher. It just looks like 2% inflation may take longer to materialize.

To sum up, Fed feels that the 100 bps cut may have done its job for now. Inflation is still higher than expected and growth is better than expected. That is not in sync with a policy of aggressive rate cuts from here on. Hence, the pace of rate cuts is likely to slow in 2025.

CME FEDWATCH FACTORS IN FEWER RATE CUTS IN 2025

The CME Fedwatch captures probabilities of rate moves at each upcoming Fed meet. This is based on implied probabilities of Fed Futures trading.

Fed Meet	275-300	300-325	325-350	350-375	375-400	400-425	425-450
Jan-25	Nil	Nil	Nil	Nil	Nil	8.6%	91.4%
Mar-25	Nil	Nil	Nil	Nil	3.2%	40.1%	56.7%
May-25	Nil	Nil	Nil	0.5%	9.2%	42.7%	47.5%
Jun-25	Nil	Nil	0.1%	2.7%	17.4%	43.9%	35.9%
Jul-25	Nil	Nil	0.3%	3.9%	19.6%	43.3%	32.9%
Sep-25	Nil	0.1%	0.9%	6.4%	23.5%	41.6%	27.5%
Oct-25	Nil	0.2%	1.5%	8.3%	25.4%	40.1%	24.6%
Dec-25	Nil	0.3%	2.2%	10.0%	26.9%	38.5%	22.0%

Data source: CME Fedwatch (# – lower probabilities consolidated)

The CME Fedwatch now has 2 milestones; June 2025, and December 2025. This is after the 25 bps rate cut in December (taking total rate cuts to 100 bps since September 2024).

• With the 2024 action done and dusted, the action now shifts to 2025 expectations. Let us look at June 2025. With rates in the range of 4.25%-4.50%; the CME Fedwatch is assigning 64.1% probability for additional 25 bps rate cut in June 2025. Probability of 50 bps rate cut by June is very low at 19.9%.
• Let us turn to December 2025. As of December, the CME Fedwatch is assigning 78% probability for overall 25 bps rate cut in June 2025. Probability of 50 bps rate cut by December stands at 39.5%. Any rate cut beyond 50 bps in 2025 has a very low probability of just about 12.5%, broadly in sync with the Fed statement.

Our reading is that by end of 2025, the total rate cuts would most likely by 50 bps, if data is normal and a remotely likely 25 bps, if inflation continues to play truant. Clearly, the CME Fedwatch appears to have toned down its dovishness substantially. In a most likely scenario, the rates at the end of December 2025 may be in the range of 3.75% to 4.00%.