Adjusting Rate Forecast as Fed Shifts Narrative

In this article we review:

• The Federal Reserve’s decision to reduce the federal funds rate by one-quarter point at its December meeting
• What appears to be a revised narrative at the Fed regarding criteria for future rate cuts 
• Changing expectations as seen in the Fed’s Summary of Economic Projections and dot plot
• The impact of strengthening economic data on Fed policy and the markets in 2025
• Our revised federal funds rate forecast for 2025 to a target range of 3.75–4.00%, reflecting two quarter-point rate cuts in 2025

As expected, the Federal Reserve reduced the federal funds target range by one-quarter point to 4.25%–4.50% at its December meeting. However, post-meeting commentary by Chair Jay Powell quickly sent markets falling based on adjustments to future rate expectations. With this in mind, we believe the following points are important for investors:

• Dot plot displays changing Fed expectations. Immediately following the release of the Fed’s statement and accompanying Summary of Economic Projections (SEP), market focus immediately surrounded the Federal Open Market Committee Participants Assessment of Appropriate Monetary Policy, more commonly known as the dot plot. In this anonymous survey of the Fed’s voting members, median expectations for the year-end 2025 fed funds rate rose to 3.9% from previous expectations of 3.4% in September, reflecting a total of two quarter-point rate cuts in the year ahead rather than four. While we have always cautioned not to read too much into Fed dot plots, which have historically displayed little correlation with actual future outcomes (December 2018 and December 2021 being prime examples), markets immediately reacted negatively to this change. 
   
• Chair Powell’s press conference further unnerved the markets. In his post-meeting press conference, Chair Powell seemed to shift the recent narrative from one of “calibration” of rates to a lower level (a term he used several times at the September and November press conferences but not this one) to one of data dependence specifically pertaining to inflation. Specific comments from Mr. Powell included, “As for additional cuts, we’re going to be looking for further progress on inflation;” and, “I think from this point forward it’s appropriate to move cautiously and look for progress on inflation;” and when asked if the calibration phase was over, he replied, “We are … in a new phase of the process.” This commentary, in our view, represents the criteria necessary for further rate cuts in 2025 being at a modestly higher bar than the previous 100 basis points (1%) of reductions since last September.
   
• Recent inflation reports trending in a different direction. The Fed’s preferred inflation measure, personal consumption expenditures (PCE) core inflation, reached a year-over-year cycle low of 2.6% in June, but since that time has gradually trended higher to 2.8% for November. Furthermore, in the SEP, Fed members increased their expectations for core PCE from 2.2% to 2.5% in 2025. Thus, the change in narrative was not a great fit with the Fed’s slightly more hawkish view of inflationary trends regarding rate cut timing.   
   
• Recent economic data has strengthened, likely playing into Fed expectations. In particular, 3Q U.S. gross domestic product growth was revised higher to 3% by the Bureau of Economic Analysis the day immediately following the Fed’s meeting, and the Atlanta Fed’s tracking estimate for 4Q is currently slightly above that pace. This provides for a high probability of cumulative economic growth closing out the year above 2.5%. As a likely lower-for-longer tax and less onerous regulatory environment awaits in 2025, we view this improving economic backdrop as a favorable one for credit and equity investors during the year ahead, even in the event of a comparatively less accommodative Federal Reserve.  
   
• Adjusting our fed funds rate expectations by one-quarter point. Given these developments, we now see two quarter-point rate cuts from the Fed in 2025 as being most realistic, thereby concluding CY 2025 with a target fed funds range of 3.75%–4.00%. Further out on the yield curve, we believe the 10-year Treasury yield is likely to stay close to current levels, perhaps closing CY 2025 at approximately 4.50%. We continue to see a favorable risk/reward profile for intermediate-term, investment-grade bonds, and we are maintaining our year-end price target on the S&P 500® of 6,500.   

2025 Year-End Forecasts

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