The Federal Reserve's December interest rate meeting is approaching, and the market is betting on a 25 basis point rate cut.
The decision of the Federal Reserve's December interest rate meeting will be announced on December 19th Beijing time. As of press time, data from CME Group shows that the market expects a 95.4% chance of a 25 basis point reduction by the Federal Reserve in December.
From a data perspective, the two important data related to the Fed's interest rate cuts - non farm employment and CPI - fluctuated last month. According to data released by the US Bureau of Labor Statistics, the US CPI rose by 2.7% year-on-year in November, which is in line with market expectations of 2.7%, compared to the previous value of 2.6%; The core CPI increased by 3.3% year-on-year, which is in line with market expectations of 3.3%, compared to the previous value of 3.3%. In November, the United States added 227000 non farm jobs, higher than the expected 220000; The unemployment rate was 4.2%, exceeding market expectations of 4.1%, compared to the previous value of 4.1%.
Federal Reserve Chairman Powell's previous remarks hinted that the Fed would cautiously cut interest rates. On December 4th local time, Powell stated in a media interview that due to the stronger economy than previously expected, the Federal Reserve can adopt a more cautious attitude when cutting interest rates. This is Powell's last public statement before the December interest rate meeting.
Against the backdrop of a rebound in CPI, higher than expected unemployment rate, and Powell's hawkish remarks, why does the market still expect the Federal Reserve to cut interest rates by 25 basis points at its December meeting? What will happen to the Federal Reserve's subsequent monetary policy?
Inflation rebound will not hinder December interest rate cuts
From the perspective of expectations, in the past month, the possibility of the Federal Reserve lowering its forecast by 25 basis points in December has increased from 61.9% to 95.4%, an increase of 33.5 percentage points.
Hu Jie, a professor at the Shanghai Advanced Institute of Finance at Shanghai Jiao Tong University and former senior economist at the Federal Reserve, analyzed Pengpai News that although US inflation data is gradually approaching the ideal level of 2%, the "last mile" of inflation is somewhat sticky, with CPI data rising in the past three months and core CPI remaining flat for three consecutive months. However, the changes in energy, rent, and wage indicators in the relevant price indicators are still optimistic, with only food showing an increase. Overall, it is still supported that the Federal Reserve will cut interest rates by 25 basis points in December.
According to data released by the US Bureau of Labor Statistics, on a year-on-year basis, the energy index decreased by 3.2% in November, while the food index increased by 2.1%; On a month on month basis, the homeowner equivalent rent index increased by 0.2%, while the rent index increased by 0.2%, marking the smallest monthly increase since April 2021 and July 2021, respectively. The average monthly rate of hourly wages in November recorded 0.4%, and the average annual rate of hourly wages recorded 4%, unchanged from the previous month.
Hu Jie believes that among the more important price factors mentioned above, only the growth rate of the food index remains on the rise, while the growth rates of other indices have decreased or remained the same as last month. Therefore, although the CPI and core CPI are not ideal, the Federal Reserve is still likely to cut interest rates by 25 basis points at its December meeting.
The current inflation data will not be an obstacle to the December interest rate cut, but it will enhance the uncertainty of the subsequent interest rate cut path, "Bai Xue, Senior Deputy Director of Research and Development Department of Oriental Jincheng, told The Paper." The rebound in CPI in November is related to the base effect, and the core inflation data has slightly decreased from 3.33% to 3.319%, without a significant rebound. The most weighted rent inflation has also fallen month on month, releasing a good signal of inflation cooling down. Based on recent statements from Federal Reserve officials, most of them believe that the labor market has basically completed rebalancing and is no longer a source of rising inflation levels. Based on the inflation data in recent months, the downward trend of inflation has not ended, but the speed and slope of de inflation have been relatively fluctuating. Therefore, with the focus of the Federal Reserve's policy decisions still on employment, November inflation data will not be a reason to hinder a rate cut in December.
Hu Jie said that in the short term, this interest rate cut may become the endpoint of this round of interest rate cuts, that is, the Federal Reserve may stop cutting interest rates at the interest rate meeting in January next year. However, the general trend of interest rate cuts will not change, and the Federal Reserve will continue to cut interest rates next year.
Be alert to potential accidents that may occur next year
The market has always been paying attention to Powell's speech. On December 4th, after Powell's media interview, the market expected the probability of the Federal Reserve lowering the target range of the federal funds rate by 25 basis points in December to rise to 75.7%, while betting on the possibility of a pause in interest rate cuts in January next year. However, some argue that this view overlooks the uncertainty of "data dependence" and is an overinterpretation of Powell's speech.
Hu Jie believes that overinterpreting Powell's speech is not appropriate. The working logic of the Federal Reserve relies on monthly data releases, and market predictions of the Fed's monetary policy should also be judged based on historical data. At the same time, as far as the current situation is concerned, investors need not pay too much attention to the comments of the Federal Reserve on economic performance. The expression of the Federal Reserve on inflation can more influence the subsequent actions of the Federal Reserve.
Bai Xue stated that Powell's cautious attitude towards the subsequent path of interest rate cuts fully reflects that the Federal Reserve has begun to remain vigilant about the potential surprises that may arise in 2025. The "overinterpretation" of Powell's speech mainly reflects the market's attempt to find clues to the clear direction of subsequent monetary policy from his speech, against the backdrop of significant uncertainty in the implementation intensity and timing of the "Trump 2.0" policy. However, although concerns about expected short-term "re inflation" have been clearly reflected in the transaction, there is currently no other sufficient evidence in the market except for uncertain higher tariffs and plans to expel immigrants. Therefore, even if interest rate cuts are suspended in January next year, it only represents the Federal Reserve entering a policy observation period and does not mean the end of the interest rate cutting cycle.
Bai Xue believes that in the current situation of fluctuating inflation and unclear policy trends, the visibility of the Federal Reserve's policies is indeed low, but it still relies on data for monthly evaluations. Therefore, the signal released by Powell is best used as a rough direction for reference and cannot serve as a basis for decision-making at the next meeting.
According to a research report by Guoxin Futures on December 17th, Powell's press conference (after the interest rate resolution) will be a crucial moment for interpreting market expectations. Powell may continue to emphasize "data dependence" during the meeting, stating that future monetary policy will be adjusted based on inflation and the actual performance of the job market. This means that although the December rate cut may be a foregone conclusion, Powell's speech will still determine whether the market expects the Federal Reserve to adopt a more moderate pace of rate cuts.
Dot matrix or display a biased "eagle" attitude
The dot matrix diagram will also be announced at this meeting. In September, the Federal Reserve released a dot matrix chart showing that the median forecast for the federal funds rate in 2025 had dropped from 4.1% in June to 3.4%. After two interest rate cuts, the current target range for the federal funds rate is 4.5% -4.75%.
Hu Jie stated that the dot plot can only be used as a reference for predicting next year's interest rate level. If there are any changes in the subsequent monthly data, the interest rate level will still change compared to the dot plot. Hu Jie predicts that the Federal Reserve will continue to cut interest rates by about 100 basis points month by month next year, and the final interest rate will remain around 3%. The pace and process of interest rate cuts, such as whether a meeting in the middle will pause the cut or if the decline exceeds 25 basis points, depends on the data for the month.
Bai Xue believes that the current US economy and job market have maintained strong resilience, with better than expected non farm employment in November and a stable unemployment rate. In terms of the economy, the GDP Now model of the Federal Reserve predicts that the quarter on quarter annualized GDP of the United States in the fourth quarter of this year will be about 3.3%, much higher than the 2.8% in the third quarter. In addition, the possible deportation of immigrants, imposition of tariffs, and tax cuts that Trump may implement after taking office may increase the risk of inflation rising next year, especially in the second half of next year. Bai Xue predicts that the Federal Reserve may take a hawkish stance at this meeting and provide a more cautious interest rate chart, showing that the Fed will cut interest rates 2-3 times in 2025, and the final interest rate may be between 3.5% and 3.75%.
In terms of the pace of interest rate cuts, Bai Xue believes that interest rate cuts will mainly focus on the first half of the year: on the one hand, inflation will fall back against the backdrop of a high base in the first half of 2024; On the other hand, the effects of Trump's various policies since taking office have not yet been fully demonstrated. In the second half of next year, as the risk of re inflation increases, the Federal Reserve may gradually stop cutting interest rates.
According to a research report by Guoxin Futures on December 17th, the dot matrix chart after the December meeting is expected to show the target range of interest rates for 2025 to 3.375% -3.625%. Looking ahead to 2025, the pace of interest rate cuts by the Federal Reserve may tend to be moderate, with an expected range of 50-75 basis points in the first half of 2025. However, this process will be limited by economic growth and inflation performance. The pace of interest rate cuts by the Federal Reserve will depend on economic data, especially the performance of inflation and wage growth. In the second half of 2025, the Federal Reserve may pause interest rate cuts due to increased inflationary pressures and enter a wait-and-see period.