Fed Adopts Cautious, Data-Driven Approach
The Federal Reserve delivered a 25-basis-point (bp) rate cut in the December FOMC meeting, bringing total cuts to 100 bps over three months. However, the Fed signaled greater uncertainty about the timing and extent of further cuts, reflecting hawkish revisions to its economic projections for 2025 and beyond. The most significant change was a 30-bp increase in the median core Personal Consumption Expenditures (PCE) inflation projection for 2025, highlighting stalled progress on inflation.
Figure 1. Diffusion index of FOMC participants’ assessments of uncertainty of Core PCE inflation
Source: Federal Reserve
Fed officials now anticipate a slower decline in inflation, a resilient U.S. economy, and heightened fiscal policy uncertainty. Future rate cuts are expected to follow a more gradual, data-driven approach. While the first 50-bp cut was prompted by fears of rapid labor market weakening, the threshold for further cuts is now higher. Once paused, the Fed will require strong evidence to resume easing. Market pricing suggests a January cut is unlikely, but cuts in March and June remain possible.
Fiscal policy uncertainty under the new administration
Fiscal policy uncertainty is a key factor that reinforces the Fed's cautious stance. The Fed's focus on inflation reflects concerns over potential fiscal policy shifts under the new administration. With his prior experience and a strong drive to make an immediate impact, Trump is expected to move quickly in implementing his policies. However, Trump's policy toolkit includes trade policy changes, which could simultaneously push inflation higher and dampen growth, posing challenges to the Fed’s dual mandate of price stability and maximum employment.
“It’s not unlike driving on a foggy night or walking into a dark room full of furniture. You just slow down.”
In light of these factors, the Fed is adopting a deliberate, wait-and-see approach. For now, the Fed has the flexibility to wait and monitor developments in 2025 before making further monetary adjustments. The upward revisions to the Fed’s projections provides them with more flexibility after cutting rates by 100 bps. With the policy rate now at 4.25%–4.5%, it aligns more closely with Taylor-rule estimates, allowing the Fed to adjust its pace based on changing economic conditions.
For the Fed to pivot from gradual cuts to rate hikes, significant global supply shocks would need to sharply raise inflation and influence inflation expectations. Even in such a scenario, the resulting drag on growth and the labor market could offset the need for hikes. Conversely, if the U.S. economy underperforms and the labor market weakens, the Fed may accelerate cuts to align policy with Taylor-rule estimates.
In any case, we are entering 2025 with a more data-dependent and cautious Fed.