NEWS AND INSIGHTS | INSIGHTS

CIO Notebook: Fed Cautious Ahead of Stronger Growth, Policy Changes

December 19, 2024
Shannon Saccocia, CFA, Chief Investment Officer—Private Wealth

We believe focus will shift to fiscal policy from monetary moving into 2025 and expect above trend US economic growth will act as a counter to the potential drag represented by a slower path to the neutral fed funds rate, helping to grow earnings and setting the stage for a broadening out in equity markets

As expected, the Federal Open Market Committee lowered the fed funds target rate by 0.25% to a range of 4.25% to 4.50%. There was one lone dissenter – Beth Hammack – who preferred to maintain rates at the prior level, but Fed Chair Jerome Powell admitted that it was a “closer call” overall in the meeting. The only major change in this month’s statement was the inclusion of a phrase “the extent and timing of” when discussing additional adjustments to the target range for Federal funds. There were no changes to the statement in terms of balance sheet management; the Fed will continue to reduce its holdings of Treasury securities and agency debt and agency mortgage-backed securities.

More importantly, the Fed released an updated dot plot which reflected a marked shift in terms of rate cut expectations from the September release. Specifically, the dot plot now represents only two cuts in the fed funds rate for 2025 versus the four cuts telegraphed in last quarter’s plot – this implies that the fed funds rate target will be between 3.75% and 4.25% at the end of 2025. In addition, with only two cuts projected for 2026 and one for 2027, the terminal or neutral rate sits at 3.1% from 2.9% in the previous quarter. Admittedly, there have been some large moves in the dot plot over the last two years, so there is some skepticism in terms of what these changes necessarily implied.

Drilling into the changes, the push higher in the dot plot was driven in large part by the increase in growth and inflation expectations as well as a lower unemployment rate. Specifically, the Fed is now projecting that the US economy will grow by 2.5% in 2024 and 2.1% in 2025, versus 2.0% for both years in the September’s projections. In addition, the Fed is expecting inflation to be stickier, with core PCE closing this year at 2.8% and 2.5% next year; this compares with September’s 2.6% and 2.2%, respectively. In the Fed’s view, unemployment will tick only modestly higher in 2025 to 4.3% and will remain there through 2027. In terms of factors incorporated into the Fed’s new projections, Powell admitted that some respondents considered potential policy changes in their assessments while others chose not to do so or chose not to indicate their approach either way. This is perhaps the biggest shift since November’s presser, where Powell indicated that policy projections were not an explicit factor in the Fed’s decision at that time.

Broadly, the press conference was punctuated by Powell’s continued insistence that the U.S. economy remains strong but that the Fed was sensitive to the need to be appropriately restrictive against still higher than target inflation, tempered with concern around a labor market which is looser than 2019 and still showing signs of slowing. While he admitted that the downside risks to the labor market have “diminished”, he acknowledged that US consumers continue to struggle with high prices even as disinflation has occurred. He also recognized the weight of higher rates on the housing market – a likely hot button topic as he heads back to Capitol Hill in the new year. What is clear is that Powell and the rest of the FOMC are going to remain highly data dependent moving into 2025. In addition, we believe that concerns around tariffs and immigration as well as potential pro-growth policies are top of mind for the Fed, given the threat of squandering the progress made on inflation since the first hike in March 2022.

Not surprisingly, US equity markets sold off meaningfully, as expectations were perhaps centered more closely around three rates cuts in 2025 versus the two outlined in the dot plot. The dollar continued to strengthen (certainly something to watch), gold was lower, volatility spiked, and Treasury yields moved higher on the shift in future expectations. Despite this reaction, it is our belief that the focus will shift to fiscal policy from monetary policy as we move into 2025. In addition, we believe above trend economic growth in the US will act as a counter to the potential drag represented by a slower path to the neutral fed funds rate, helping to grow earnings and setting the stage for a broadening out in the equity markets.

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