Fed meeting recap: hawkish quarter point rate cut

Fed market recap: Hawkish quarter point rate cut

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Overview

• Fed funds rate lowered by 25bps per market expectations. However, with one dissent for hold, and an updated dot plot showing the median official expecting only 2 cuts in 2025, this is decidedly a hawkish cut.
• Updated Fed economic projections show timeframe to their 2% inflation target pushed out by a full year. September median estimates had PCE at 2.1% next year, however it is now at 2.5%, and 2.1% is now expected for 2026.
• The median long-run Fed funds rate has increased slightly to 3%, confirming policymaker’s views of a higher neutral rate.
• Powell stated during the post FOMC conference that “we are significantly closer to neutral.” and “from this point forward, it’s appropriate to move cautiously and look for progress on inflation.” The pause button has certainly been pressed as the Fed waits to assess the impact of their cuts, new economic data, and last but not least, Trump’s policies.
• Market timing for the next Fed cut significantly pushed back, with pricing for a full cut to occur now in 2H of 25.
• Classic strong hawkish surprise reaction from markets, with equities diving, yields jumping, and USD surging to 2022 heights. See market moves below:

Market moves

Betashares Fixed Income desk comments

• Wait and see appears to be (once again) the new order. The Fed is a lot more data dependent, and uncertainty on Trump’s actual policies certainly doesn’t help. Powell is saying that “we need to take our time, not rush and make a very careful assessment.” Though Powell did admit that some Fed official have already started to incorporate potential Trump policies when they pencilled in greater uncertainty about disinflation.
• Whilst the market was expecting upward revisions from the Fed and for the gap between the dot plot and pre-FOMC market pricing to close, what they didn’t expect for was for the gap to close entirely. Therefore, the market reacted by moving even more hawkish post FOMC.
• Higher yields from higher uncertainty may continue to provide good opportunities to add duration as volatility comes back into play. On a relative basis, market pricing for volatility in bonds could still be more realistic than in equities which may make duration a good value hedge against drops in equities. The barbell approach makes sense in an environment of heightened vol, especially with how stretched longs are and the potential for rapid deleveraging in equities.
• QT (quantitative tightening) continues with the Fed having shrunk its balance sheet by approximately $2 trillion from the 2022 peak. Though there are still more than $6 trillion left.

The new dot plot

10 out of 19 policymakers had 3.9% for their 2025 year-end forecast, with 4 above that and 5 below. Interestingly, one person was at 3.1%, while the highest projection was at 4.4% (the latest fed funds rate, meaning no additional easing factored in).

Source: Bloomberg. As at 18 December 2024.

The new markets pricing

First cut fully priced in July – the feeling is of much higher uncertainty now for both the timing and path of rates.

Source: Bloomberg. As at 18 December 2024.

New Fed economic projections

Powell feels very good about the economy: “If you look around the world there is a lot of slow growth and struggles with inflation. I feel very good about where the economy is”. This is the technocratic equivalent of chanting “USA! USA! USA!”? It is clear that the Fed now feels little pressure from the economy and the labour market to hurry with cuts, and whilst disinflation is still happening, they need to see further progress on inflation before more cuts.

Source: US Federal Reserve Board

Long run history of Fed funds rate vs US 2- and 10-year government bond yields

Source: Bloomberg. As at 19 December 2024.