FOMC Cuts Funds Rate 25 BP; Strongly Hints at Rate-Cutting Pause

– Powell: After 100 BP of Cuts, Policy Rate Closer to Neutrality

– Powell: Now Appropriate to Ease More Cautiously, Slowly

By Steven K. Beckner

(MaceNews) – Three months after it began a decisive easing of monetary policy, the Fed took a tentative step on Wednesday toward slowing or perhaps interrupting that process.

Much as expected, the Fed’s policy-making Federal Open Market Committee gave the U.S. economy an early Christmas gift by cutting short-term interest rates for the third straight meeting by another quarter percentage point.

However, it could be the last such gift for a while, as the FOMC left the future path of monetary policy in doubt and signaled that further cuts in the federal funds rate are likely to be more limited and sporadic.

Given slower than hoped progress in reducing inflation, participants significantly pared back their projected rate cut reductions for the next two years, implying a more gradual easing strategy. Reinforcing that impression, the FOMC revised its forward guidance portion of its policy statement, although not as radically as some had speculated it might.

What’s more, Chair Jerome Powell made clear he and fellow policymakers will be proceeding “slowly” and “cautiously” as they seek to balance their goals of “maximum employment” and returning to “price stability,” defined as 2% average inflation.

Speaking to reporters after the rate cut announcement, he said the FOMC will continue to move toward a “more neutral” monetary stance but said it has now entered “a new phase in the process.”

Having lowered the federal funds rate by a total of 100 basis points, Powell said “we’re significantly closer to neutral.”

Although monetary policy is “still meaningfully restrictive,” he said it’s now “appropriate to move more cautiously.”

Powell said he and his colleagues will be “watching” the cooling labor market, but said the economy is “in a good place” to allow the central bank to use relatively restrictive credit to make further progress against inflation. So, he said, “going forward, we’re obviously going to be moving slower ….”

The FOMC, in a split vote, lowered the funds rate by 25 basis points to a target range of 4.25% to 4.5% — a median 4.4%.

Cleveland Federal Reserve Bank President Beth Hammack dissented in favor of no change in the funds rate. Governor Michelle Bowman, who had dissented against the initial FOMC rate cut, voted with the majority.

It had previously lowered the Fed’s policy rate by 50 basis points on Sept. 18 and by 25 basis point move on Nov. 7. The Fed’s cumulative 100 basis points of easing leaves the funds rate 140 points above the FOMC’s upwardly revised 3.0% estimate of the “longer run” or “neutral” level, which presumes a 1.0% real interest rate (r*) plus the Fed’s 2% inflation target.

The 19 FOMC participants now project significantly less easing over the next two years.

When the FOMC began cutting the funds rate aggressively three months ago after leaving it at 5.25% to 5.5% for 14 months, its quarterly Summary of Economic Projections depicted a steady course of further rate reductions. Not only did the 19 participants anticipate the additional 50 basis points of 2024 rate cuts, which have now been accomplished, they projected the funds rate would fall to a median 3.4% by the end of 2025 (a range of 3.25% to 3.5%), and to 2.9% by the end of 2026 (a range of 2.75% to 3.0%).

Now, in their revised quarterly SEP, FOMC participants foresee a less steep descent. They project the funds rate will end 2025 at a median 3.9% (a target range of 3.75-4.0%) — 50 basis points higher than in the September SEP. By the end of 2026, they anticipate a funds rate of 3.4% (a target range of 3.25-3.50%) — also 50 basis points higher than in September. By the end of 2027, they project the funds rate to be 3.1% (a range of 3.0-3.25%) — 25 basis points higher than in September.

Continuing their reassessment of funds rate neutrality, FOMC participants estimated the “longer run” (or neutral) funds rate to be 3.0%. Over the past year, the longer run rate has been revised up repeatedly from 2.5%.

That implies a higher level for the neutral nominal rate.

The higher median disguises a good deal of uncertainty and dissension over where “neutral” really lies. Estimates of the longer run rate ranged from 2.4% to 3.9%. Those who estimate a higher longer run funds rate have been arguing recently that the Fed’s rate setting is already near neutral and that therefore not much more easing is needed.

If r*, the real component of the neutral rate, is as high as 2%, as it was once thought to be and as some think it is again, then the nominal neutral rate would be around 4%, not far from the current level.

The new funds rate “dot plot” was accompanied by revised economic forecasts.

The officials now forecast that PCE inflation will end 2025 at 2.5% – compared to the 2.1% forecast in September. Core PCE inflation is also expected to close out next year at 2.5% — compared to 2.2%. PCE inflation is forecast to fall to 2.2% in 2026 and to 2.0% in 2027. Their forecast of 2.1% real GDP growth for 2025 is up from the 2.0% forecast in September, and well above their 1.8% estimate of the longer run GDP growth rate (or “potential”). The unemployment rate is forecast to be 4.3% next year, down from 4.4% in the September SEP. it is expected to remain 4.3% in 2026.

The FOMC cut rates despite strong, consumer-led growth, relatively encouraging labor market news and less encouraging inflation news from the Labor Department. It reported that non-farm payrolls rebounded more than expected in November, growing by 227,000. Prior months payrolls were revised up substantially. The unemployment rate increased to 4.2% from 4.1%, as labor force participation dipped, but average hourly earnings rose more rapidly, leaving them up 4% from a year earlier.

The consumer price index ticked up to 0.3% last month or 2.7% from a year ago (each up a tenth from October). The core CPI also rose 0.3%, leaving it up 3.3% year over year.

The FOMC did not change its characterization of economic conditions in its policy statement.

It did make a change in the “forward guidance” portion of the statement, adding a phrase to state “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”

Powell said the “extent and timing” language was intended to convey that, after 100 basis points of easing, “if the economy does evolve as anticipated, we’re at a point where it may be appropriate to slow” rate-cutting.

The “extent and timing” wording “signals we are at or near the point where it would be appropriate to slow” the pace of easing, he said at another stage.

The FOMC’s goal is to make monetary policy more neutral, and “clearly that distance has shrunk by 100 basis points,” he said.

Although the new funds rate dots are not drastically different from the September ones, they could be seen as less dovish, or at least more contingent, in light of Powell’s comments.

Powell’s cautious tone reflects the fact that, since the FOMC began cutting rates aggressively in mid-September, the consensus for easing has increasingly splintered. The voices of patience in the face of persistent inflation, economic strength and uncertainty about funds rate neutrality have grown louder; the calls for uninterrupted rate cuts softer.

Speaking for the Committee as a whole, Powell’s guarded comments reflected this divergence of opinion. He acknowledged Wednesday’s decision was “a closer call,”

In particular, Powell emphasized ongoing concern about inflation while downplaying risks to employment in his press conference. Asked what would prompt the FOMC to cut rates again, he said it will “look for further progress on inflation” along with labor market conditions.

While saying that the Fed has made “significant progress” toward its 2% inflation goal in reducing PCE inflation from 5.6% to 2.8%,, he said “inflation has underperformed relative to our expectations.”

To lower rates further, Powell strongly implied that the FOMC needs to see better inflation data: “We really want to see progress on inflation … as we think about further cuts .…”

“We’re going to want to see further progress on reducing inflation and keeping a solid labor market.”

Powell said he remains confident that inflation is headed toward 2%, but lamented that in recent months it has just been “moving sideways.”

Progress against inflation has been “slower than we hoped …,” he went on. “The job is not done.”

Powell declared that the Fed is “not going to settle for” inflation above 2% but will remain “committed to achieving that.”

Meanwhile, on the “maximum employment” side of the Fed’s dual mandate, he said “the labor market has cooled from its formerly overheated state,” but “remains solid.”

Explaining the latest rate cut and accompanying pause signal, Powell listed five factors which the FOMC considered: stronger than expected GDP growth and hence reduced downside risks to the economy; higher than forecast inflation; closer proximity to neutrality, and greater uncertainty.

Uncertainty about tariff policy under the incoming Trump administration was one source of uncertainty, although he said the Fed hasn’t really begun to incorporate higher tariff scenarios into its forecasting model.

Powell reiterated that upside and downside risks are now “roughly balanced” and said the FOMC will try to steer a “middle” course between easing too quickly and easing too slowly. Doing the former could risk reviving inflation, while doing the latter could hurt the economy he said.

For now, both the economy and monetary policy are “in a good place,” he asserted, adding that “we want to keep it that way.”

Pressed on the health of the labor market, Powell said, “we do think the labor market is still cooling by many measures, and we’re watching that carefully, but it’s not cooling in a way that really raises concerns.”

With wage gains slowing, he said the labor market is “not a source of inflationary pressures”.

Unlike earlier in the easing process, it was noted that Powell did not use the term “recalibration” to describe rate-cutting, and he acknowledged, “We are, though, in a new phase in the process, just because we have reduced the policy rate by 100 basis points.”

“We’re significantly closer to neutral, (but) we’re still meaningfully restrictive,” he continued. “From this point on it’s appropriate to move more cautiously (and to) continue reducing inflation….Going forward, we’re obviously going to be moving slower.”

Powell went on to say, “it’s appropriate to proceed cautiously now that we’re 100 basis points closer to neutral, and the economy is in good shape; we can make progress on inflation because policy is still meaningfully restrictive.”

On the issue of where the “neutral” rate lies, he said, “we don’t know exactly where it is, but we know it by its works.”

“We know we’re 100 basis points closer …. we’re a lot closer to it…,” he went on. “We’re in a new phase, and we’re going to be more cautious about future cuts.”