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Well, it’s that time of year again and Powell & Co. had to make the decision whether to give the money and bond markets a gift of cheer or a lump of coal in their stocking. At the December Federal Open Market Committee (FOMC) meeting, the Federal Reserve (Fed) decided to give investors a 25-basis point (bps) rate cut stocking stuffer. This latest easing move was widely expected and brings the new Fed Funds trading range down to 4.25%–4.50%.

Now comes the more uncertain aspect of this easing cycle as we move into 2025, i.e., the pace and magnitude of any potential future rate decreases. In a highly data dependent monetary policy world, that will leave plenty of room for further speculation going forward. However, as we get ready to close the books on 2024, it does appear the Fed may not necessarily be cutting rates at successive FOMC meetings as had been the case since the policy makers began this process back in September.

One important aspect that comes to mind is the notable difference in the narrative that accompanied the December FOMC gathering as compared to back in September. Three short months ago, the Fed, and by extension, the money and bond markets, were operating under the assumptions that the economy/labor markets could be cooling more than previously expected and that disinflation was continuing, which would result in an aggressive Fed rate cutting cycle. Indeed, at one point, the implied probability for Fed Funds Futures was looking at a 2.80% target by Q4 2025 and Treasury yields had plunged by 100 bps.

Now, recent data have revealed a continued resilient economy, with the labor market showing signs of not being as cool as originally thought, while inflation numbers hit a roadblock. Needless to say, these developments completely changed Fed rate cut expectations with Fed Funds now being discounted to be at roughly 3.80% by the end of next year and U.S. Treasury coupon yields all being back well over the 4% threshold, as of this writing.

Where do Powell & Co. go from here? The Fed Chairman has reiterated that policy has been “recalibrated” with the goal of becoming less restrictive and moving the Fed Funds target down to neutral territory, data permitting. That’s where the uncertainty comes in. What is a neutral Fed Funds rate? In our opinion, the level is now higher than what prior Fed estimates had been showing, and at a minimum, it could be at least 3.5%, or 3.75%. The policy makers seem to think the neutral rate has risen, but what the Fed decides is the appropriate level may be a moving target in the months ahead.

If the voting members follow through on bringing the Fed Funds target down to the aforementioned neutral reading and stop easing there, that would mean there could potentially be only a couple of rate cuts for 2025.

One other policy aspect to be on the lookout for from the Fed is their plan for quantitative tightening (QT). The policy makers have already tapered their pace of balance sheet reduction, so it wouldn’t be out of the question at all if the next step in the months ahead would be to end QT at some point in 2025.

The Bottom Line

At a minimum, a reasonable case scenario could involve the Fed taking a pause to reassess things to begin 2025. That doesn’t necessarily mean the rate cut cycle would end. However, the policy makers have already cut rates by 100 bps, so perhaps Powell & Co. “taking stock” could make sense.