Powell testimony to Congress – No hurry to cut rates

12 Feb 2025 , 10:38 AM

A SIGNIFICANT TESTIMONY BEFORE THE US CONGRESS

The chairman of the US Federal Reserve regularly testifies before the Senate Banking Committee of the US Congress and also takes questions on the direction of monetary policy. In his latest testimony on February 11, 2025, there were a host of questions pertaining to sensitive issues like the direction of monetary policy, preparedness for monetary surprises, impact of Trump tariffs etc. While Jerome Powell avoided committing to any political outcomes, he persisted with his view that free trade was more growth accretive than tariffs. On monetary policy, Powell emphasized that Fed was in no hurry to cut rates, despite hints from Trump that rate cuts were called from. Politics and policy were not entirely in sync.

HOW TO NAVIGATE THE NEW ECONOMIC LANDSCAPE?

A key point in the Fed testimony to the Congress was the impact of the recent Trump policies on monetary policy. For instance, the higher tariffs on imports and the forced deportation of labour were likely to spike inflation as well as disrupt labour markets in the short run. In the past, protectionist policies led to a spike in inflation. However, Powell was totally non-committal on the likely impact such policies could have on the trajectory of monetary policy. In the US, fiscal policy is outside the purview of the Fed. However, Powell clarified that he stood by his previous remarks made in 2018 that “countries promoting open trade with no barriers led to faster growth and higher incomes.” Trump justified tariffs on the grounds that Canada, Mexico, and China were imposing trade deficits on the US.

One concern has been that higher tariffs, like the recent 25% tariff on all steel and aluminium products, would add to domestic costs. That, by itself, would be inflationary. Interestingly, the Treasury Secretary, Scott Bessent, had recently proposed to bring down long term interest rates by targeting the 10-year bond yields. Normally, that is the domain of the central banks, but the Trump government wants to indirectly regulate rates too. However, such dissonance has not helped much. For example, there has been a recent spike in the Uncertainty Index, as also a souring of consumer sentiments amidst inflation fears.

INTEREST RATE CUTS WILL BE SLOWER THAN EXPECTED

On the rate outlook, the message from Jerome Powell was quite clear. Rate cuts will be slower than originally expected. Between September 2024 and December 2024, the Fed had cut rates by 100 basis points. However, the Fed had maintained status quo on rates in the Jan-25 meet and it looks like the Fed may maintain status quo in the first half of calendar 2025. There are some obvious macro numbers to support this view. In the first advance estimate of Q4 GDP growth, the US Bureau of Economic Analysis (BEA) has pegged fourth-quarter real GDP growth at 2.5%. This is 60 bps lower than Q3, but still healthy.

The data on labour markets and inflation also support a watchful approach to further rate cuts. In the latest reading, consumer inflation crossed 3% while PCE inflation is approaching 3%. That is much higher than the Fed interest rate target of 2%. Trump tariffs and the labour market disruption are likely to add to inflation. On the labour data front, while non-farm payroll additions may have been slightly benign in January 2025, the unemployment rate has fallen to a more acceptable 4.0%. To sum up; inflation is too high to justify rate cuts, while comfortable GDP and labour data rule out any tearing hurry to cut rates.

HOW THE CME FEDWATCH SEES RATE CUTS IN 2025?

Here is how the CME Fedwatch (based on implied probabilities in Fed Futures trades) probabilities look like after Jerome Powell’s testimony to the Congress.

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	4.0%	96.0%	Nil
May-25	Nil	Nil	Nil	Nil	Nil	0.7%	20.3%	79.0%	Nil
Jun-25	Nil	Nil	Nil	Nil	0.3%	7.7%	41.3%	50.7%	Nil
Jul-25	Nil	Nil	Nil	Nil	1.5%	13.3%	42.9%	42.4%	Nil
Sep-25	Nil	Nil	Nil	0.4%	4.7%	21.2%	42.7%	31.0%	Nil
Oct-25	Nil	Nil	0.1%	1.2%	7.5%	24.9%	40.7%	25.7%	Nil
Dec-25	Nil	Nil	0.3%	2.5%	11.2%	28.3%	17.5%	20.2%	Nil
Jun-26	Nil	0.2%	1.2%	5.5%	16.3%	30.3%	32.0%	14.5%	Nil
Dec-26	0.1%	0.9%	4.0%	12.1%	24.2%	30.2%	21.0%	6.6%	0.9%

Data source: CME Fedwatch

As of December 2024, the Fed has cut rates by 100 bps to the range of 4.25% to 4.50%. Here are the expectations up to December 2026.

• As of Jun-25, the probability of status quo (4.25%-4.50%) and a 25 bps rate cut are almost having equal probability.
• As of Dec-25, there is still a 20% probability of status quo, 80% probability of 1 rate cut and a 62% probability of 2 rate cuts (likely) or more.
• As of Jun-26, there is still a 47% probability that rate cuts will not be more than 25 bps from current levels and 77% probability of maximum 2 rate cuts only from here.
• By Dec-26, there is still 29% probability of up to 1 rate cut and 59% probability of not more than 2 rate cuts.

These are early days to project 2026 probabilities, but the message from CME Fedwatch is that there could, at best, be 1 more rate cut of 25 bps in 2025 and another 25 bps rate cut in 2026.