The Federal Reserve reduced its policy rate by 25 basis points to a range between 4.25% and 4.5% at its meeting on Wednesday while communicating to policymakers and the public that its reductions will be on pause until it gets a better sense of the policy changes to come.
We are updating our forecast on the federal funds policy rate to two reductions of 25 basis points next year.
We are updating our forecast on the federal funds policy rate to two reductions of 25 basis points next year with risk that the next rate cut may not occur until March at the earliest and that the next reduction would not come until the second half of the year.
The Fed’s Summary of Economic Projections implies two 25 basis-point cuts next year, and the Fed’s terminal rate has been lifted to 3% from 2.9%.
One of the major takeaways from the SEP is that the Fed has reduced its forecast of four 25 basis-point rate cuts next year to two.
Looking ahead, the federal funds rate forecast for next year now stands at 3.9% in contrast with the 3.4% it forecast in September.
In 2026, that forecast is now 3.4% compared with 2.9% previously, while the federal funds rate estimates for 2026 and 2027 are 3.1% and 3%, respectively.
In addition, the Federal Open Market Committee lifted its estimate for its preferred measure of inflation, the personal consumption expenditures price index, to 2.5% next year and the core PCE to 2.5%. The Fed does not anticipate reaching its 2% inflation target until 2027.
The Fed lifted its estimate of gross domestic product next year to 2.5% from 2% it had forecast in September. The Fed now expects 2.1% in 2026 compared to 2% previously.
The unemployment rate forecast was revised down to 4.2% from 4.4% this year and to 4.3% next year in contrast with the 4.4% posted in September.
The Fed lowered the rate it pays on reverse repurchases by 5 basis points, which will add to bank reserves inside the primary dealer banks.
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While this move will improve liquidity in the banking system on the margin, it was not what the market is looking to see, which was an announcement on when quantitative tightening begins to be reduced.
We do not believe that such a move is in the cards until March at the earliest. When that reduction begins, we expect it to be gradual and orderly.
There was one dissenter, Cleveland Fed President Beth Hammack, in favor of keeping the policy rate in a range between 4.5% and 4.75%.
Looking ahead
It is appropriate that the Fed takes time to ascertain the impact of expansionary fiscal policies, higher tariffs, eased regulations and tighter immigration that are all likely under a new administration. To a certain extent, these coming changes might create the conditions for substantial changes to the forecast.
It was not lost on anyone listening to Federal Reserve Chairman Jerome Powell during his news conference that he noted the labor market is not currently a source of inflation.
One does not have to read between the lines about how that dynamic may change given the likelihood of tighter immigration policies. Such restrictions could contribute to rising wages and raise the risk of a wage-price spiral that would put upward pressure on inflation.
Powell also noted that the Fed is in the preliminary stages of considering the impact of tariffs on the economy. But he was careful to note that without knowledge of the policies’ details, it is premature to come to any conclusions on the economic impact, let alone a Fed policy path.
It will be some time—perhaps well into later 2025—before the fog of policy uncertainty lifts and allows the Fed to make its judgement.
While the Fed’s policy decision on Wednesday is likely to be labeled a hawkish cut, in our estimation that is an intellectually unsatisfying description of where the Fed is now and of the policy crosswinds that the Fed will need to navigate in the years ahead.
A prudent pause in our estimation acknowledges the reality of significant changes to come in fiscal and trade policy. And Powell in his remarks acknowledged that prospect, that the Fed is not on a pre-determined path in its monetary policy and maintains the flexibility to address the balance of risks that it also noted in its policy statement.
