Fed minutes hint at rate cuts only after inflation tapers

24 Feb 2025 , 02:14 PM

FIRST THE INFLATION HORSE, THEN THE RATE CUT CART

In the last few Fed meetings, the Fed had cut rates by 100 bps in 3 tranches between September 2024 and December 2024. These rate cuts had been implemented despite the inflation continuing to remain sticky. The wager was that the cumulative impact of all the rate hikes would eventually bring down inflation. In a sense, the Fed had put the cart before the horse. However, inflation continued to be stubborn and the latest consumer inflation reading in the US for January 2025 shows inflation at 3.0%, a full 100 bps above the Fed target. That is clearly not acceptable to the members of the FOMC.

The minutes of the Fed meeting, held on January 28-29, were published 3 weeks later on February 19, 2025. The Federal Open Markets Committee (FOMC) is quite categorical that it would not be willing to put the cart before the horse any longer. The gist of the FOMC minutes was that some real demonstration of inflation tapering was required, before further rate cuts could happen. The FOMC also admitted that the risk of a spike in inflation, at this juncture, was much higher than the risk of slowing growth. The CME Fedwatch is now expecting just 1 rate cut of 25 bps in 2025 and 1 more rate cut of 25 bps in 2026. We will come back to that towards the end.

WHAT WE READ FROM THE MINUTES OF THE FOMC JAN-25 MEET?

Here are some key inferences that we could draw from a reading of the Fed minutes published on February 18, 2025.

• The FOMC was categorical that it would need to see more evidence of inflation coming down to lower levels before it could undertake any further rate cuts. Clearly, the 3.0% inflation for January 2025 has come as a surprise. The PCE inflation to be announced next week, is also expected to have edged higher.
• The FOMC members have expressed apprehensions that the Trump reciprocal tariffs and immigration restrictions had the potential to raise costs of goods and services and stoke inflation. However, it is still not clear whether Trump really intends to implement all these announcements or they are merely being used as a bargaining chip?
• The consensus of the FOMC members was that apart from the inflation number, the FOMC would also have to be clear about the actual impact of the tariffs and immigration restrictions. The FOMC would look at further rate cuts only after it was convinced that Trump’s policies were not overtly impacting inflation. It will need time to evaluate.
• The FOMC members underlined that they would not be too worried about growth and jobs, unless the unemployment rate went up substantially above the 4% mark. Until then, the entire focus of the FOMC would be on how to curtail inflation and bring it back to the eventual Fed target of 2%. Rate trajectory would be based on this thinking.
• The inflation impact would depend on whether the impact of higher tariffs is absorbed by the companies or passed on to the consumers. Indications are that it could be passed through and transmitted to the customers. In that case, the impact on inflation would be immediate and also quite sharp, something the Fed is apprehensive about.
• The FOMC members also pointed out that there was substantial optimism about the economic outlook. This optimism stemmed from an expectation of easing in government regulations or changes in tax policies. If that happens, it could be growth accretive, in which case, greater attention to inflation than to jobs and growth, would be warranted.
• The markets are already anticipating that the next round of rate cuts may not come before August 2025, by when the impact of Trump policies on growth and inflation should be quite apparent. Fed funds rate are currently in the range of 4.25% to 4.50%, which is a full 100 bps lower than the peak rates.

Let us now turn to what the CME Fedwatch says about rate trajectory.

CME FEDWATCH HINTS AT 1 RATE CUT EACH IN 2025 AND 2026

The CME Fedwatch is based on implied probabilities of Fed Futures trading.

Fed Meet	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475
Mar-25	Nil	Nil	Nil	Nil	Nil	Nil	2.0%	98.0%	Nil
May-25	Nil	Nil	Nil	Nil	Nil	0.2%	12.7%	87.1%	Nil
Jun-25	Nil	Nil	Nil	Nil	0.1%	5.5%	44.0%	50.4%	Nil
Jul-25	Nil	Nil	Nil	Nil	1.3%	14.2%	45.5%	38.9%	Nil
Sep-25	Nil	Nil	Nil	0.5%	5.8%	25.1%	43.2%	25.4%	Nil
Oct-25	Nil	Nil	0.1%	1.5%	9.5%	28.6%	39.8%	20.5%	Nil
Dec-25	Nil	Nil	0.5%	3.5%	14.3%	31.4%	34.9%	15.3%	Nil
Jun-26	Nil	0.2%	1.5%	6.5%	18.6%	31.9%	29.8%	11.5%	Nil
Dec-26	0.6%	2.2%	7.6%	17.8%	27.6%	26.6%	14.2%	3.3%	0.2%

Data source: CME Fedwatch

We now have CME Fedwatch expectations till December 2026 and here is the gist.

• As of Jun-25, CME Fedwatch is assigning 50.4% probability for status quo and 94.4% probability of maximum 1 rate cut.
• By December 2025, CME Fedwatch is assigning 15.3% probability to status quo and just over 50% probability for maximum of 1 rate cut. This looks the likely scenario.

Probabilities for 2026 are still evolving but the best case expectation is of 1 rate cut n 2025 and 1 more rate cut of 25 bps in 2026. That would also depend on impact of Trump tariffs. Anything beyond that would only happen if there were a real growth scare! That surely gives some breathing room for the RBI to crystallize its own thought process.