WASHINGTON – On Wednesday, the Federal Reserve announced a quarter percentage point reduction in its key interest rate, marking the third consecutive rate cut. This decision was accompanied by a measured approach regarding additional reductions in the coming years.
As anticipated by financial markets, the Federal Open Market Committee (FOMC) adjusted its overnight borrowing rate to a target range of 4.25%-4.5%. This move brings the rate back to levels last seen in December 2022, during a period of rate increases.
While the rate adjustment itself was expected, the focus remained on the Fed's forward guidance amidst persistently high inflation and solid economic growth—conditions that traditionally do not align with policy easing.
By implementing the 25 basis point cut, the Fed signaled the possibility of only two more rate reductions in 2025, according to the “dot plot,” which reflects individual members’ future rate projections. This marks a significant reduction from the committee's intentions outlined in the September update.
Assuming these adjustments continue in quarter-point increments, officials anticipate two additional cuts in 2026 and another in 2027. Over the long term, the FOMC projects the “neutral” funds rate at 3%, a slight increase of 0.1 percentage point from the September forecast, reflecting a gradual upward trend throughout the year.
“With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” stated Federal Reserve Chair Jerome Powell during a post-meeting press conference. “We can therefore be more cautious as we consider further adjustments to our policy rate. Today was a closer call, but we decided it was the right call.”
Following the announcement, the stock market experienced a sharp downturn, with the Dow Jones Industrial Average plummeting over 1,100 points. Treasury yields surged, and futures pricing suggested a scaled-back outlook for rate cuts in 2025, as per CME Group’s FedWatch tool. Powell acknowledged the swift pace of rate adjustments thus far, emphasizing a slower trajectory moving forward.
For the second consecutive meeting, dissent emerged within the FOMC. Cleveland Fed President Beth Hammack voted against the rate cut, preferring to maintain the previous level. This follows Governor Michelle Bowman’s dissent in November, marking the first instance of a governor voting against a rate decision since 2005.
The federal funds rate, which governs overnight lending rates between banks, also influences consumer borrowing costs, including mortgages, auto loans, and credit cards. The post-meeting statement featured minimal changes, except for subtle language shifts regarding the “extent and timing” of future rate adjustments. Analysts at Goldman Sachs interpreted this as a signal of a slower pace of cuts ahead.
Evolving Economic Projections
The rate cut was implemented despite the Fed revising its 2024 full-year GDP growth projection upward to 2.5%, an increase of 0.5 percentage points from September. However, officials expect GDP growth to decelerate in subsequent years, aligning with the long-term growth forecast of 1.8%.
In addition, the Fed adjusted its unemployment projections, lowering the expected rate to 4.2% for the current year. Inflation estimates, based on the Fed’s preferred metrics, were raised slightly to 2.4% for headline inflation and 2.8% for core inflation—both figures remaining above the Fed’s 2% target.
Despite macroeconomic indicators such as 3.2% projected GDP growth in the fourth quarter and a steady 4% unemployment rate, officials remain cautious. They aim to avoid excessively high rates that could unnecessarily stifle economic momentum. A recent Fed report indicated only slight economic growth in recent weeks, with signs of waning inflation and reduced hiring activity.
Challenges Ahead
The Fed must also contend with fiscal policies proposed by President-elect Donald Trump, including tariffs, tax cuts, and potential deportations, all of which could heighten inflation and complicate monetary policy.
“We need to take our time, not rush, and make a very careful assessment. But only when we’ve actually seen what the policies are and how they’ve been implemented,” Powell commented regarding Trump’s plans. “We’re just not at that stage.”
Policy Normalization
Powell described the rate reductions as part of an effort to recalibrate monetary policy under current conditions, stating, “We think the economy is in a really good place. We think policy is in a really good place.”
Since September, the Fed has reduced its benchmark rate by a full percentage point, including a rare half-point reduction during that month. The Fed typically prefers smaller, quarter-point changes to evaluate the effects of its actions incrementally.
However, markets have reacted differently. Mortgage rates and Treasury yields have risen sharply, indicating skepticism about the Fed’s ability to implement further cuts. The 2-year Treasury yield, closely tied to monetary policy expectations, climbed to 4.3%, surpassing the Fed’s target range.
In a related move, the Fed adjusted the rate paid on its overnight repo facility to the lower end of the fed funds rate. This adjustment addresses concerns about the funds rate drifting toward the lower end of its target range, with the ON RPP rate acting as a floor for the funds rate.
This cautious and measured approach by the Federal Reserve highlights the complexity of balancing economic growth, inflation, and monetary policy in an evolving fiscal landscape.
