Rate Cuts With Dangers Ahead

The FED finally did what everyone expected. It cut interest rates. BUT… what does this actually mean in practice? Because yes, the cut was anticipated, but the FED’s reasoning, Powell’s concerns, and the forecasts for the coming years… have a lot more substance than we thought.

RATE CUT

The FED proceeded yesterday with a cut of its benchmark interest rate by 25 basis points (0.25%), bringing it down to the 4.00%–4.25% range.

This move signals the first official shift toward a more expansionary monetary policy after months of waiting and hesitation.

Specifically, this decision came after a period of 100 basis points in cuts during the first half of 2024, followed by eight months of stability with no further moves. During this time, inflation remained “stuck” at high levels, despite hopes for easing.

So why did they move to cut now? The truth is that this decision isn’t only about inflation. The main reason the FED lowered rates is the deterioration in the labor market. The picture is generally complex, with the economy showing signs of fatigue, and the FED seems unwilling to risk a wave of layoffs that could push the economy into recession.

As Powell put it clearly: “The balance of risk has tilted toward the labor market. This is a difficult situation.”

And at the same time, there’s the issue of tariffs. The Trump administration has reinstated tariffs on many imported goods, something that could increase inflation, but likely only temporarily. Powell himself said: “Inflation will rise due to tariffs, but we don’t expect this to be persistent.”

DOT PLOT

In the so-called dot plot — the chart with projections from the 19 FOMC members — the forecast for the end of 2025 fell to 3.6% (from 3.9%). For 2026, 3.4% (from 3.6%), and for 2027, 3.1% (from 3.4%).

source

This means the path is downward, but slow. However, there’s significant divergence among members. Some foresee a much faster pace of cuts, with one projecting 1.25% lower by the end of 2025. Others see a slower pace, or even a pause, if the data demand it.

Still, it’s very likely we’ll see two additional cuts by the end of 2025, and another TWO cuts in 2026. This is because the FED has entered a trajectory of supporting the labor market and does not appear willing to sacrifice it for an inflation rate that no longer “burns” as it once did.

Of course, the dot plot functions more like a “map” of expectations rather than a 100% guarantee. But the direction has shifted. And that’s what matters.

WHAT POWELL SAID

Now let’s turn to FED Chair Jerome Powell and his regular press conference, which gave us plenty of insights into the FED’s thinking.

Powell acknowledged that risks to employment have increased and that the balance of risks has shifted. He said the FED will make decisions on a meeting-by-meeting basis, given the uncertainty, and that there’s no preset path. He emphasized that tariffs have had a smaller and slower effect than expected, with limited pass-through to consumers. He also spoke of a housing shortage and structural problems in the real estate market. Finally, he admitted that the framework of monetary policy requires constant reassessment and that the FED is open to external review.

Essentially, Powell is caught between two goals: price stability and employment. And for now… he seems to be choosing employment.

Posted Using INLEO