The Federal Reserve delivered a hawkish surprise at its December meeting, with a more aggressive forecast for interest rates and inflation, despite expecting a rate cut. The decision, which was expected to be dovish, resulted in a sharp selloff in risk assets and a spike in treasury yields.
The Fed cut its benchmark rate by 25 basis points to 4.25-4.5%, but said it expects the rate to fall to 3.9% in 2025, suggesting only two rate cuts next year, down from its previous forecast of four cuts. Some Fed members also incorporated potential changes to trade, immigration, and fiscal policy into their forecasts, leading to a firmer inflation path and rate path.
The outcome has raised the risk that a January rate cut is off the table. Morgan Stanley analysts now expect only two rate cuts in 2025, in March and June, while ING expects the Fed to remain on hold in January and still calls for three 25bps rate cuts in 2025.
The Fed’s hawkish tilt has also led to a significant drop in confidence in the ability to combat disinflation, with ING saying that markets are not fully pricing in another rate cut until July. The bank also expects the rate cut cycle to pause in January, unless there is a dramatic unexpected development, such as a change in fiscal policy direction. Wells Fargo also agrees that the Fed is likely to keep rates on hold at its January meeting, barring “dramatic unexpected developments.”
