The Fed Makes the Cut — For the Third Time

Key Takeaways

• As expected, the Federal Reserve’s Federal Open Market Committee (FOMC) at its December meeting cut interest rates by 0.25%. The federal funds target rate range now stands at 4.25% to 4.50%.
• The FOMC’s final projections for the year showed two rate cuts for 2025 vs. the four that had been predicted in September.
• The S&P 500 Index finished the day nearly 3% lower after the news broke of fewer expected rate cuts next year.
• The FOMC statement had just one minor change from November, reflecting Chair Powell’s post-meeting comments that they Fed will take a “more cautious” approach when it comes to rate cuts in 2025.

At their December meeting, the Federal Open Market Committee (FOMC) saw 11 of the 12 voting members agree to a 25-basis-point cut, bringing the fed funds rate range to 4.25% to 4.50%. This was the third interest-rate cut in 2024, a move 62% of the market had predicted at the start of the week. While the meeting met the majority’s expectations with a 25-basis-point cut, the Fed’s new estimates of 50% fewer rate cuts in 2025 sent ripples through the markets, with the S&P 500 Index finishing almost 3% lower on the day.

“With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” said Chair Jerome Powell at a post-meeting news conference. “We can therefore be more cautious as we consider further adjustments to our policy rate.”

The Fed’s median dot-plot projections increased the expected fed funds rate in 2025 to 3.75% to 4.00% (a 50-basis upward revision from September estimates) and in 2026 to 3.25% to 3.50% (a 50-basis-point increase). There was also a revision for 2027 to 3.00% to 3.25% (a 25-basis-point increase). This would translate to two 25-basis-point cuts in 2025, two 25-basis-points cuts in 2026, and one in 2027.

In the December Summary of Economic Projections, GDP growth projections were revised significantly upward, with the median expectations rising from 2.0% to 2.5% for 2024, along with a 10-basis-point increase to 2.1% for 2025. These projections were also accompanied by a slightly lower projection for unemployment for this year (4.2% vs. 4.4% in September) and 2025 (4.3% vs. 4.4%). For 2026 and beyond, projections remained mostly unchanged from September for GDP and unemployment.

“The U.S. economy is just performing very, very well — substantially better than our global peer group,” Mr. Powell said. “The outlook is pretty bright for our economy. We have to stay on task, though.”

On the inflation front, FOMC projections were revised upward from September estimates from 2.6% to 2.8% for 2024, 2.2% to 2.5% for 2025, and 2.0% to 2.2% for 2026, before returning to the Fed’s 2% objective by 2027.

“For additional cuts, we’re going to be looking for further progress on inflation,” Chair Powell said.

Incoming data since the November meeting have continued to show a resilient economy, with solid income and spending data and a rebound in labor market conditions following strike- and hurricane-related disruptions in October. Even though the unemployment rate increased slightly to 4.2% in November, it still remains below the 4.4% that FOMC participants had projected in September for the fourth quarter. On the inflation front, the inter-meeting period brought two promising core CPI inflation prints, rounding to 0.3% month-over-month.

The Fed’s most recent statement showed only a minor edit from November that reinforced the committee’s commitment to be “more cautious” going forward.

Median Projections for Fed Funds Rates (2024-2027 and Beyond)

After the Fed announcement, the 10-year Treasury ended the day higher and finished at 4.50%; short and long rates were also higher. The Dow Jones Industrial Average and S&P 500 Index returned -2.58% and -2.95%, respectively, for the day.

10-Year Treasury Yield Over the Past 12 Months

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In Conclusion

The 25-basis-point rate cut at the final FOMC meeting of the year did not surprise investors, but the market did not respond well to Fed expectations of fewer rate cuts in 2025. Still, the Fed struck an optimistic tone overall, including a lack of alarm around the recent firming in inflation. While inflation has been higher than what the FOMC projected in September, GDP prints and labor market data appear to support the FOMC’s more optimistic revisions to their September projections, showing the U.S. economy will continue to perform well in a higher interest-rate and higher inflation environment. With rate-cut expectations for the FOMC’s next meeting in January ending the day at 8.6%, according to the CME Groups Fedwatch Tool, and projections for inflation to return back to the FOMC’s 2% target pushed out to 2027, investors may not want to hold their breath for a meaningful reduction in rates in 2025, as the risk to markets in the committee’s eyes are nonexistent, but inflation still remains stubborn.

Definitions

One basis point is equal to 0.01%.

The Consumer Price Index (CPI) measures the overall change in consumer prices based on a representative basket of goods and services over time. Core CPI is the change in prices of goods and services, except for those from the food and energy sectors.

The Core Personal Consumption Expenditure (PCE) Price Index provides a measure of the prices paid by people for domestic purchases of goods and services, excluding the prices of food and energy. The core PCE is the Fed’s preferred inflation measure.

The federal funds rate is the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight.

The Dow Jones Industrial Average index (DJIA) tracks the share price of the top 30 large, publicly-owned U.S. companies which is often used as an indicator of the overall condition of the U.S. stock market.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.

Loose or easy monetary policy is intended to stimulate the economy by making it cheaper for people and businesses to borrow money.

The S&P 500 Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market.

The Summary of Economic Projections (SEP), known informally as the “dot plot,” is a collection of forecasts for the economy, inflation, the labor market, and interest rates offered by the seven Fed governors and 12 regional Fed presidents.

U.S. Treasury notes are debt securities issued by the U.S. and are loans made by the investor to the government with varying lengths of maturity.

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