Fed minutes hint at inflation concerns over Trumponomics

9 Jan 2025 , 10:25 AM

WHAT HAPPENED IN THE 21 DAYS TO THE FED MINUTES

In the US, there is a full 21 days gap between the Fed policy statement and the minutes. The Fed minutes of the policy meet held on 18-Dec were published on 08-Jan and the minutes did underline some key inflation concerns. The concerns are that the Trump tariff policies could make imports more expensive and prop up inflation, considering the elevated trade deficit that the US runs. There were two key data points in the intervening 21 days. The PCE inflation for November inched up from 2.3% to 2.4%, going farther from the 2.0% target.

However, the final GDP growth for September quarter came in as a positive surprise as it got upgraded by 30 bps to 3.1%. The Fed policy statement had already hinted at reducing the rate cuts in 2025 from four to two. Now, the higher inflation raises the risk of cutting rates, while the surge in GDP growth does away with the need to cut rates. That was reflected in the minutes of the FOMC presented on January 08, 2025.

INSIGHTS WE GATHERED FROM THE FOMC MINUTES

Clearly, one signal is that the last mile inflation may be stickier than anticipated (especially core inflation). Hence the argument for rate cuts becomes weaker. Here are key takeaways.

• One thing that emerged from the minutes of the Fed meeting was that the decision to cut rates by 25 bps in December (on top of 75 bps cut till November) was a close call. The views were divided on both sides, with the hawks wanting the Fed to go slow on rate cuts to keep its options open. However, the rate cut club finally prevailed.
• However, the other thing that emerged from the minutes of the Fed meet was that the number of rate cuts would be 50 bps in an optimistic scenario and 25 bps in a most likely scenario in year 2025. This is a sharp reduction from the original estimate of an additional 100 bps of rate cut in the year 2025. Inflation is not supportive of that view.
• The last headline PCE inflation reading had seen a 10 bps hike to 2.4%, while the core PCE inflation had remained static at 2.8%. In fact, the rolling averages of headline inflation and core inflation are increasingly diverging from the 2% target mark. This only underlines the view of members like Michelle Bowman that; last mile was the toughest.
• The downside risk for American households is that they would see the cost of mortgages, car loans and credit cards going up as interest rates stay higher than expected for a longer period. The FOMC is now pencilling in 2 rate cuts of 25 bps each in a best case scenario with likely scenario of just 1 rate cut of 25 bps in year 2025 overall.
• Most FOMC members were wary of the Trump effect on inflation. Trump takes charge later in January and his strong policy approach on trade tariffs and on immigration is already well known. However, such strong policies would mean raising the cost of imports and also raising the labour costs, as the flow of immigrants reduces.
• A recent report by Goldman Sachs has underlined that the impact of Trump’s trade tariff policies and his restrictive immigration policies could combine to push up inflation by nearly 50 bps. If that was to be the case, then the markets have to be prepared for sharply lower number of rate cuts in the year 2025, and possibly even in 2026.

One good development is that the Fed is expected to end its balance sheet downsizing. With the bond portfolio of the Fed down from $9 Trillion to $6.9 Trillion, it is expected to stabilize at around $6.3 Trillion by May 2024. That will improve liquidity conditions.

CME FEDWATCH HINTS AT 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	4.8%	95.2%
Mar-25	Nil	Nil	Nil	Nil	1.8%	39.2%	59.0%
May-25	Nil	Nil	Nil	0.3%	8.7%	42.8%	48.2%
Jun-25	Nil	Nil	0.1%	3.6%	22.0%	44.9%	29.3%
Jul-25	Nil	Nil	0.7%	6.6%	25.8%	42.3%	24.5%
Sep-25	Nil	0.2%	2.0%	10.7%	29.3%	38.6%	19.3%
Oct-25	Nil	0.4%	3.1%	13.1%	30.5%	36.1%	16.8%
Dec-25	0.1%	0.7%	4.1%	14.9%	31.1%	34.1%	15.1%

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 Dec-24 (taking total rate cuts to 100 bps since September 2024).

• Let us look at June 2025. With rates in the range of 4.25%-4.50%; the CME Fedwatch is assigning 70.7% probability for additional 25 bps rate cut in June 2025. Probability of 50 bps rate cut by June is at just 25.7%.
• Let us turn to December 2025. CME Fedwatch is assigning 84.9% probability for overall 25 bps rate cut and a probability of 50 bps rate cut by December stands at 50.8%. However, this also means that there is 50% chance of just 1 rate cut in 2025.

Our quick view is that by end of 2025, the total rate cuts may be limited to 25 bps; with 50 bps cut remote unless inflation progresses towards 2% mark. CME Fedwatch has toned down its dovishness. A lot will depend on inflation and the Trump effect; but that is good news for India. This largely reduces the risk of monetary divergence.

For the RBI, rate cuts are a lot more complex as it would weaken the rupee, something the RBI cannot afford when the rupee has already weakened sharply to ₹85.87/$. We may have to look at the interest rate outlook afresh, after Trump officially takes charge!