Investors are almost certain that the Federal Reserve will make its last interest rate cut of 2024 this week, but the bigger question is whether the Fed is ready to reduce expectations for rate cuts in 2025.

All eyes will be on the so-called "dot plot," a chart updated quarterly that shows each Federal Reserve official's forecast for the direction of the federal funds rate.

In September of this year, when the Federal Reserve initiated its first rate cut in four years, the dot plot revealed a consensus among officials for two more cuts in 2024 and four additional small cuts in 2025.

However, following a series of stubborn inflation readings and cautious comments from Federal Reserve officials, the prediction for 2025 is now in question. Some Federal Reserve observers also expect that the policies of the new Trump administration will create more challenges for Fed decision-makers.

Former Cleveland Fed President Loretta Mester stated that last year's prediction of four rate cuts "must be rethought" and forecast that the pace for 2025 would "slow down." She believes that "two or three cuts seem appropriate to me."

Some Federal Reserve observers disagree with this view, arguing that Fed officials will stick to the estimate of four cuts in 2025.

"The overall story is that they still expect inflation to decline," said Luke Tilley, chief economist at Wilmington Trust, who anticipates that the median forecast for 2025 will remain at four cuts. "They still believe that interest rates are restrictive."

Federal Reserve Chairman Powell has left enough room for the Federal Reserve to take a slower pace if necessary. He stated in early December, 'We can afford to be a little more cautious' because the economy is stronger than expected earlier in the fall.

The anticipated pullback is due to two developments occurring at the end of 2024 that have caught some economists off guard:

First, the labor market has not shown new signs of weakness. Second, inflation has remained sticky this fall, refusing to make the final drop towards the Federal Reserve’s 2% target.

The latest evidence comes from the inflation data released by the Bureau of Labor Statistics last week, showing that the Consumer Price Index (CPI) rose 2.7% year-on-year in November, slightly up from 2.6% in October.

After excluding the volatile food and Energy costs, the core CPI climbed 3.3% year-on-year in November, holding steady at the same level for the fourth consecutive month. Producer prices also unexpectedly rose in November, adding to the series of stubborn inflation data.

However, traders reacted positively to the new readings, further raising bets on a Federal Reserve rate cut this week, pushing the probability above 95%.

Some also do not expect the Federal Reserve’s projections for 2025 to change. Tilly believes that the dot plot released on Wednesday will show that the median target interest rate forecast for the end of 2025 will still be between 3.25% and 3.5%.

He stated, 'Federal Reserve officials must acknowledge the slightly higher inflation numbers recently, but must also pay attention to the state of the labor market, which, despite being volatile, has generally slowed down.' Compared to most Federal Reserve members, Tilly is more concerned about the labor market, as he believes the possibility of a recession due to labor market weakness stands at 35%.

Tilly also pointed out that labor demand is declining, with the six-month average of private sector job growth dropping to 108,000. He sees the labor market slowing to nearly 100,000 positions per month.

Wilmer Stith, the bond portfolio manager at Wilmington Trust, is another Fed watcher who expects four rate cuts next year.

He expects Powell to say on Wednesday that the Fed has made progress on its inflation target, particularly improvements in housing prices and other CPI components. "These all point to the story that 'we are getting closer to the target,'" Stith said. As for any actions this week, "I think a 25 basis point cut is almost a done deal."

Some Fed officials provided optimistic assessments of the inflation outlook. Richmond Fed President Barkin mentioned in mid-November that he expects inflation to continue declining next year.

He attributed the recent core inflation stagnation to tougher year-on-year comparisons. He said the inflation reading for the first quarter of 2025 might be better due to higher readings in the first quarter of this year—this development caused officials to pause for thought at the time.

Chicago Fed President Goolsbee urged a more macro perspective when he spoke in early December, noting that the USA has experienced a significant decrease in inflation rates since they peaked at 9% in 2022, the highest level since 1981. "I still believe we will reach 2%," he added.

But Mester stated that recent readings, including last week's CPI, should be sufficient for Fed officials to reconsider the path for 2025.

She said, "I think aside from the fiscal policy actions that are known but not yet clarified that are coming, there should be a rethinking of the appropriate policy path for next year."

She added that a rate cut is still possible this week, as that is the market's expectation. However, there may be a pause in January after that. "They are more likely to take action in December and then consider matters for next year."

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