The Fed could be on the verge of ripping up its rate script for 2025

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Investors are betting a final 2024 rate cut Wednesday is a sure thing from the Federal Reserve, but the bigger question is whether the central bank is ready to scale back what it expects to do in 2025.

You are viewing: The Fed could be on the verge of ripping up its rate script for 2025

All eyes will be on the “dot plot,” a chart updated quarterly that shows the prediction of each Fed official about the direction of the federal funds rate.

In September, as the central bank initiated its first rate cut in more than four years, the dot plot revealed a consensus among Fed officials for two more cuts in 2024 and four small additional reductions in 2025.

Now that the 2025 projection is in question following a string of stubborn inflation readings and cautious commentary from Fed officials. Some Fed watchers also expect the policies of the new Trump administration to create even more challenges for central bank policymakers.

That prior prediction for four rate cuts next year has “got to be rethought,” former Cleveland Fed president Loretta Mester told Yahoo Finance, predicting a “slowing down” for 2025.

Two or three cuts in 2025 “seems right to me.”

Some Fed watchers disagree, saying Fed officials will stick with their estimates for four cuts in 2025.

“The story overall is they still expect inflation to come down,” said Wilmington Trust chief economist Luke Tilley, who expects the median 2025 estimate to stay at four reductions. “They still think rates are restrictive.”

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Fed Chair Jerome Powell has left enough breathing room for the Fed to adopt a slower pace if needed, saying in early December that “we can afford to be a little more cautious” because the economy is stronger than expected earlier in the fall.

The potential for a pullback in expectations is due to two developments late in 2024 that surprised some economists.

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First, the job market did not show any new signs of weakness. Second, inflation has remained in a stubborn sideways holding pattern this fall, refusing to make the final descent toward the Fed’s 2% goal.

That latest evidence came last week when inflation data from the Bureau of Labor Statistics showed that the Consumer Price Index (CPI) increased 2.7% over the prior year in November, a slight uptick from October’s 2.6% annual gain in prices.

On a “core” basis, which strips out the more volatile costs of food and gas, prices in November climbed 3.3% over last year for the fourth consecutive month.

Wholesale prices also rose more than expected in November, adding to the string of sticky inflation prints.

But traders reacted to the new readings by boosting their bets for a Fed cut this week even higher, pushing the odds above 95%.

And some don’t expect the Fed’s 2025 predictions to budge either. Tilley of Wilmington Trust believes the median estimates for how far rates will fall by the end of 2025 to still be in the range of 3.25%-3.5% once the dot plot is released Wednesday.

Fed officials “will have to give a nod to the more recent inflation numbers that have stayed a little bit high, but also focus on the labor market which has had a lot of volatility but slowed down on balance,” he said.

Tilley is more worried about the job market than most members of the Fed, seeing a 35% chance of a recession on account of labor market weaknesses.

Tilley also notes demand for labor is dropping, with private sector job growth now down on a six-month average to 108,000. He sees the labor market slowing down to almost 100,000 jobs a month.

Wilmer Stith, bond portfolio manager for Wilmington Trust, is another Fed watcher who also sees four rate cuts still happening next year.

What he expects Powell to say Wednesday is that the Fed is making progress on its inflation goal, pointing to progress on shelter prices and other segments of CPI.

Federal Reserve chair Jerome Powell speaks at the New York Times DealBook Summit in New York on Dec. 4. (AP Photo/Seth Wenig) · ASSOCIATED PRESS

“Those sort of bode well, for this narrative of ‘we’re getting closer and closer to our goal,'” Stith said.

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As for any moves this Wednesday, “I think it’s a sure bet for a 25 basis point rate cut.”

Some Fed officials have offered optimistic assessments of the inflation outlook. Richmond Fed president Tom Barkin told Yahoo Finance in mid-November that he expects inflation will continue to drop next year.

He chalked up the recent flat readings on core inflation to tougher comparisons from the prior year.

Inflation readings in the first quarter of 2025 could look better, he said, since the first quarter of this year showed higher readings — a development that gave officials pause at the time.

Chicago Fed president Austan Goolsbee also urged a bigger-picture outlook while speaking in early December, noting that “we’ve had a massive drop in the inflation rate” since it peaked at 9% in 2022, which at the time was the highest level since 1981.

“I still think we’re going to 2%,” he added.

But Mester told Yahoo Finance the recent readings, including CPI last week, should be enough to give Fed officials second thoughts about 2025.

“I think there’s going to be a rethink about what that appropriate policy path may have to look like next year, even aside from prospective fiscal policy actions, which are still largely unknown, but we know are coming,” she said.

A rate cut is still likely this week, she added, because that’s what the market expects. But that could be followed by a pause in January.

“They are more likely to follow through in December and then think about next year.”

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