Behind Closed Doors
Recently published minutes show that the Federal reserve (the “Fed”) had less confidence than in prior months. While there was only one dissenting vote, many officials appear to have been in two minds about whether to leave rates as they were.
The final decision was, to quote the minutes themselves ‘finely balanced’.[1]
Why the hesitation? Chiefly, two factors:
Progress on inflation is perceived to have stalled in the last quarter of 2024, and at higher risk of remaining elevated.
The approach of the incoming administration on trade, regulation, and fiscal policy is unclear yet.
Markets were somewhat shaken, not by the interest rate decision itself, which was expected and largely welcomed, but by the noticeable change in outlook in the Fed’s revised projections for the coming year.
While optimistic about economic growth and employment, the projections showed inflation would remain higher for longer, not reaching the target 2% level until 2027. Accordingly, only two rate cuts are forecast in 2025, compared to the four predicted in the previous projections.[2]
The overall impression is less one of gloom than of uncertainty. As Chairman Jerome Powell put it in the press conference, “It’s not unlike driving on a foggy night or walking into a dark room of furniture. You just slow down.”[3]
The Data
This may seem like a sudden shift. Until recently, the news headlines were portraying the inflation figures as on a positive trajectory. This is true if we consider the progress made since the high point of 2022.
Personal Consumption Expenditures (PCI), Percent Change from Year Ago, Monthly, Seasonally Adjusted
Source: Federal Reserve Bank of St. Louis
However, if we zoom-in on 2024 specifically, we can see an apparent reversal beginning (awaiting trend confirmation) in the final months of the year.
Source: Federal Reserve Economic Data
In September 2024, when the Fed made its first 50 bps cut, PCE inflation was at 2.1%, barely a whisker off the long-sought target. In November it had risen back to 2.4%, with Core PCE (that is, excluding food and energy) even higher at 2.8%.
Meanwhile, the president-elect Donald Trump and his team have so far hinted at a wide range of policies, some of which could lead to higher inflation.[4] For example, restricting immigration could put upward pressure on wages, and higher tariffs could lead directly and indirectly to price increases for consumer goods.
The Commentary
Recent statements made by Fed officials appear to show they are still divided in opinion. Fed governor Christopher Waller expressed optimism that inflation will go down regardless of any tariffs introduced.[5]
Colleagues such as Fed Governor Michelle Bowman have been more forthright in highlighting the threat of inflation and the resilience of the labor market.[6]
Beth Hammack, the sole dissenter in the December 2024 meeting, observed in a speech earlier that month that “Some of the forces that appeared to be holding down the neutral rate following the Global Financial Crisis may have finally run their course or reversed”.[7]
Kansas City Fed President Jeff Schmid added his view that rates may be “very close to their longer-run level now”.[8] If true, this could imply that rates are set to remain around 4% for the medium term, as opposed to the 3% the Fed is officially projecting.
The markets themselves are predicting little change in 2025, with a majority (72%) pricing in only one rate cut or none at all.[9]
Conclusion
The upshot is that no one can tell what path interest rates will take. If unemployment worsens substantially, rate cuts may become a necessity. If inflation resurges and the economy remains strong, rates could in theory begin to rise again.[10]
As usual, we at The Family Office prefer to avoid prediction and instead look more closely at the fundamentals. If Hammack is correct, and these fundamentals are shifting, we have no choice but to embrace uncertainty, stay diversified, and remain skeptical of sweeping predictions and misleading consensus.