Fed maintains 22-year high, hints at 3 rate cuts next year

The US Federal Reserve opted to maintain interest rates at a 22-year high for the third consecutive meeting, with indications pointing towards a potential shift in policy with three rate cuts anticipated in the coming year.

Fed Chair Jerome Powell, in a press statement, explained that the decision to keep the key lending rate between 5.25 percent and 5.50 percent allows policymakers to evaluate “the extent of any additional policy firming that may be appropriate.”

Notably, the inclusion of the word “any” in the statement, absent in November’s decision, serves as an acknowledgment that the Fed believes the current rate may be at or near its peak for this cycle.

Stock indexes responded positively to the Fed’s decision, witnessing a surge on Wall Street, and the Dow Jones Industrial Average closing at an all-time high.

Powell addressed reporters, stating that policymakers discussed when it would be “appropriate” for the Fed to initiate interest rate cuts, while not ruling out the possibility of another hike.

According to KPMG Chief Economist Diane Swonk, “The Fed thinks that it is done with rate hikes and is more worried about overdoing it than it was in the past.”

The Fed’s stance aligns with its ongoing efforts to curb inflation and maintain economic stability amid recent positive economic developments.

“After a period of nearly two years of rapid monetary policy tightening, a pivot to cuts next year seems like the most probable outcome,” economists at Wells Fargo conveyed to clients.

The Federal Reserve, holding a dual mandate to tackle inflation and unemployment, emerges as the first major central bank to unveil its interest rate decision this week.

The European Central Bank and the Bank of England are expected to publish their rate decisions on Thursday, likely maintaining rates in response to slowing inflation.

In addition to the interest rate decision, the Fed’s rate-setting Federal Open Market Committee (FOMC) updated its economic forecast. FOMC members reduced the median projection for interest rates at the end of next year, signaling an expectation of 0.75 percentage points in cuts.

This adjustment points towards three rate cuts in the coming year, a departure from most analysts’ predictions going into the meeting.

Powell, in a press conference, acknowledged a substantial slowdown in the fourth quarter of 2023 but emphasized the resilience of the economy due to strong consumer demand and improving supply conditions.

The FOMC now projects the US economy to grow by 2.6 percent this year, up from 2.1 percent in September, with a subsequent slowdown to 1.4 percent in 2024.

FOMC members expect headline inflation to ease more than previously anticipated, dropping to 2.8 percent this year and further to 2.4 percent in 2024. The Fed’s preferred inflation rate, excluding volatile food and energy costs, is also expected to decline more rapidly.

Powell highlighted that the slowdown in the rate of price increases is contributing to the rise in real, inflation-adjusted wages, potentially improving public sentiment amid a perceived economic divide.

Soft Landing in Sight –
Despite the Fed’s aggressive monetary tightening, economic growth has remained resilient, and the unemployment rate has stayed close to historic lows.

Analysts suggest that the data indicates the Fed is on track for a “soft landing,” a rare achievement where high-interest rates bring down inflation without triggering a damaging recession.

CFRA Chief Investment Analyst Sam Stovall expressed confidence in a soft landing for the US economy, stating, “A soft landing for the U.S. economy appears to be the most likely outcome.”

US Treasury Secretary Janet Yellen, a former Fed chair, shared a similar sentiment, calling monetary policy an art and expressing her baseline expectation for a soft landing in an interview with CNBC.

As the financial markets digest the Fed’s decision, futures traders have assigned a high probability of nearly 85 percent that the Federal Reserve will extend its pause at the next interest rate decision in January, according to data from CME Group.

This underscores the prevailing belief in a cautious approach as the central bank navigates the complexities of monetary policy in the evolving economic landscape.