Market Data
Shifting Expectations on Federal Reserve Interest Rate Cuts
The odds of the Federal Reserve cutting interest rates further this year have diminished significantly following a drop in unemployment and growing uncertainty about the economic impact of new policies from the White House. At their December meeting, Fed officials had penciled in two potential rate cuts for the year. However, economists and Wall Street investors are increasingly doubtful, with some now predicting no reductions at all in 2023. This shift in expectations is underscored by recent forecasts from economists at Morgan Stanley, who now anticipate only one rate cut in 2025. Meanwhile, futures markets suggest that investors also expect just one rate cut, likely in July. The implications of fewer cuts would mean a prolonged period of elevated mortgage rates and higher borrowing costs for everything from auto loans to credit cards. While mortgage rates are closely tied to the yield on the 10-year Treasury note, which can move independently of Fed actions, the central bank’s decisions remain a critical factor in shaping the economic landscape.
Powell’s Upcoming Testimony and Congressional Scrutiny
Federal Reserve Chair Jerome Powell is set to testify before Congress this week, appearing before House and Senate committees that oversee the central bank and the financial industry. This testimony, required by law twice a year, comes at a time when expectations about future rate cuts are shifting. Lawmakers may press Powell to accelerate rate reductions, but he is also likely to face tough questions on other high-profile issues, particularly under the Biden administration. These include crypto regulation, banking regulation, and allegations of "de-banking," a practice where banks close customer accounts deemed to pose financial, legal, or reputational risks. Crypto executives have accused Biden administration regulators of pressuring financial firms to target their industry for de-banking, adding another layer of complexity to the Fed’s decision-making process. As Powell navigates this testimony, he will need to address not only the economic outlook but also the regulatory challenges facing the financial sector.
The Fed’s Current Stance and Economic Uncertainty
Fed officials have recently indicated that after cutting their key rate three times at the end of last year—to approximately 4.3%, down from a two-decade high of 5.3%—they are likely to maintain a holding pattern for an extended period. While no official has specified how long this pause might last, the reasoning is clear: the labor market remains stable, inflation is above the Fed’s 2% target, and potential policy changes from the White House have introduced significant uncertainty. Fed Governor Adriana Kugler noted that the labor market’s stability gives the Fed time to make decisions, but inflation has “moved sideways” since the fall and remains above target. She also highlighted the potential impact of Biden administration policies, such as widespread tariffs and the deportation of immigrants, which could push up inflation. Others argue that deregulatory policies might increase supply and reduce prices. In this uncertain environment, Kugler emphasized the need for caution, stating, “The cautious and the prudent step is to hold the (Fed’s key) rate where it is for some time.”
The Role of Inflation and Policy Uncertainty
Inflation remains a key factor in the Fed’s decision-making process. While the central bank aims for a 2% target, prices have shown little movement since the fall, and officials are grappling with how to respond. Austan Goolsbee, president of the Fed’s Chicago branch, acknowledged that the Fed’s rate is likely to be lower in the next 12 to 18 months but also argued that a slower approach makes sense as the Fed nears a potential pause in rate reductions. The prospect of tariffs has further complicated the outlook, as they may cause one-time price increases without leading to persistent inflation. Goolsbee noted that discerning between one-time changes and ongoing inflationary pressures is no easy task and will take time to resolve. “We’ve still just got to wait for the dust to clear,” he said. Other officials, such as Lorie Logan, president of the Fed’s Dallas branch, have also suggested that the Fed may need to hold rates at current levels for quite some time, even if inflation were to fall close to the 2% target. With the economy largely healthy and hiring holding up, the Fed’s key rate may already be near the “neutral rate,” where it neither restricts nor stimulates growth.
The Labor Market and Its Implications for Monetary Policy
The latest jobs report has bolstered confidence that the Fed’s cutting cycle is over. Employers added a solid number of jobs last month, and the unemployment rate ticked down to 4%—a historically low level. Hiring in November and December was revised upward, suggesting a stronger labor market than previously thought. Steady hiring and a mostly healthy job market reduce the urgency for the Fed to cut borrowing rates. The Fed had implemented a steep half-point cut in September following weak hiring over the summer, which raised concerns about a potential recession. However, the recent jobs data has alleviated those fears, leading economists at Bank of America to conclude that the Fed’s cutting cycle is likely over. As the labor market continues to show resilience, the Fed is under less pressure to reduce rates, and officials are increasingly leaning toward maintaining the current rate for the foreseeable future.
The Fed’s Wait-and-See Approach
In conclusion, the Federal Reserve appears to be adopting a wait-and-see approach as it navigates a complex economic landscape. With unemployment at historically low levels, inflation above target, and significant policy uncertainty, the Fed is erring on the side of caution. While some officials still expect rates to decline over the next year, the central bank is signaling that it will not rush into further cuts. Instead, it is choosing to observe how new policies from the White House and global economic conditions evolve before making its next move. This cautious stance reflects the Fed’s dual mandate of maximum employment and price stability, as well as its commitment to avoiding unnecessary disruptions to the economy. As Chair Powell testifies before Congress and the Fed continues to monitor the data, one thing is clear: the path forward for interest rates will depend on how the economy—and the policies shaping it—unfold in the coming months.
