Federal Reserve cuts interest rates by quarter point in December

The Federal Reserve on Wednesday announced its third straight interest rate cut, lowering the benchmark rate by 25 basis points amid economic data showing that inflation remains above the central bank's target rate.

With the 25-basis-point cut, the benchmark federal funds rate will sit at a range of 4.25% to 4.5%. The Fed's move follows a 25-basis-point cut in November and a larger-than-normal cut of 50 basis points at its September meeting, which was the first reduction in rates since March 2020 and brought them down from a range of 5.25% to 5.5% — the highest level since 2001.

The Federal Open Market Committee (FOMC), the group within the Fed responsible for setting monetary policy, said in a statement that "labor market conditions have generally eased, and the unemployment rate has moved up but remains low" and while inflation has progressed toward the 2% objective, it "remains somewhat elevated."

"The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate," the FOMC added.

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One member of the FOMC, Cleveland Fed President Beth Hammack, dissented from the decision to cut rates and preferred to hold the benchmark rate at a range of 4.5% to 4.75%.

The FOMC also released a summary of economic projections, which reflected two rate cuts in 2025, two cuts in 2026 and one cut in 2027. It had previously projected four cuts in 2025 in its most recent projection from September.

The summary shows the median of the federal funds rate at 4.4% at the end of 2024, before declining to 3.9% in 2025, 3.4% in 2026 and 3.1% in 2027. Those forward-looking projections are higher than the Fed's September projections, with the 2025 and 2026 medians each a half-point higher and the 2027 figure 0.2 percentage points higher.

It also projects that the personal consumption expenditures (PCE) index, which is the Fed's favored inflation gauge, will finish this year at 2.4% and will be 2.5% in 2025 — up from 2.1% in the previous projection released in September. PCE would then decline to 2.1% in 2026 before reaching 2% in 2027 and over the longer run.

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"Today was a closer call, but we decided that it was the right call because we thought it was the best decision to foster achievement of both of our goals, maximum employment and price stability," Fed Chair Jerome Powell said at a press conference.

"We see the risks two-sided — moving too slowly and needlessly undermine economic activity and the labor market, or move too quickly and needlessly undermine our progress on inflation. So we're trying to steer between those two risks, so we decided to move ahead with a further cut," he explained. 

Powell said downside risks to the labor market have diminished, but noted that the labor market is looser than it was before the pandemic and is continuing to cool, which isn't needed to get inflation to the 2% target. He also noted that the pace of the decline in inflation has flattened over the last year in part because housing services inflation is falling at a slower pace than hoped, with some "bumpiness" in prices for goods.

"We coupled this decision today with the extent and timing language in the post-meeting statement that signals that we are at or near a point at which it will be appropriate to slow the pace of further adjustments," Powell said.

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The Fed chair responded to a question about what policymakers will consider in future rate cut decisions heading into the new year, given the signal sent by the Fed's economic projections about fewer rate cuts in 2025 than were previously forecast.

"We're significantly closer to neutral at 4.3% and change, we believe policy is still meaningfully restrictive, but as for additional cuts, we're going to be looking for further progress on inflation as well as continued strength in the labor market," he explained. "And as long as the economy and labor market are solid, we can be cautious as we consider further cuts and all of that is reflected… in the December SEP, which showed a median forecast of about two cuts next year compared to four in September." 

"The U.S. economy is just performing very, very well — substantially better than our global peer group — and there's no reason to think a downturn is more likely than it usually is. So the outlook is pretty bright for our economy. We have to stay on task, though, and continue to have restrictive policies so that we can get inflation down to 2%. We're also going to be looking out for the labor market pretty close to where it is," Powell said.

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The chair also discussed the impact of inflation in recent years on American consumers. Prices are roughly 20% higher than they were four years ago, despite inflation easing from a 40-year high of 9.1% in June 2022 to 2.7% in November 2024.

"What I think people are feeling right now is the effect of high prices, not high inflation. We understand very well that prices went up a great deal, and people really feel that and it's prices of food and transportation and heating your home and things like that. So there's tremendous pain in that burst of inflation that was very global," Powell said.

Markets fell in response to the Fed's decision, with the S&P 500 down over 1.7% in the final hour of trading and the Dow down over 1.4%. The probability of the Fed pausing its rate-cutting when it meets on Jan. 28-29 was largely unchanged in response to the Fed's decision, with a 96.5% chance of rates being held at the new 4.25% to 4.5% range next month, little changed from Tuesday, according to the CME FedWatch tool.

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"The Fed has been able to maneuver 100 basis points of cuts so far in this cycle, but given the trajectory of the economy and the recent uptick of inflation, it is going to be more difficult for the Fed to provide basis to continue cutting rates at the same pace," said Charlie Ripley, senior investment strategist for Allianz Investment Management. 

"The other reality is Powell and company cannot afford to be wrong on inflation again as upside risks continue to persist," he said. "Therefore, we see the bar being raised for rate cuts going forward from here and given this Fed is operating on a data-dependent level, any meaningful upticks of inflation raise the risk that additional rate cuts, if any, will be few and far between."

"In many ways, today's cut and the release of updated expectations for 2025 signals a strong vote of confidence in the current state of the economy and job market. And that optimism may trickle down to business leaders waiting for a firm signal to ramp up hiring," said Cory Stahle, economist at the Indeed Hiring Lab. 

"There is still a lot of uncertainty around the impact of any new policies enacted by the incoming administration, and there is no guarantee that the current market momentum can or will endure over the medium or longer term. But absent any big surprises, the labor market looks poised to enter 2025 with solid momentum and wind in its sails," Stahle added.