Federal Reserve officials are set to discuss the issue of borrowing costs at this week's meeting, with the market generally expecting another rate cut, although the cut may be smaller than previously anticipated, while also indicating that the pace of rate cuts will slow down next year. The resilience shown by the USA economy has exceeded officials' predictions from months ago, with inflation declining at a slow pace and the labor market not as weak as expected. This shift in the economic outlook may prompt the Fed to adjust its wording in Wednesday's policy statement and raise expectations for the path of borrowing costs. Additionally, stronger than expected data has sparked discussions on whether the neutral rate should be adjusted upwards, which could provide a rationale for the Fed to slowly cut rates. The Fed's interest rate decision and the latest quarterly economic forecast report will be released at 3 a.m. Beijing time on Thursday. Following that, Fed Chairman Jerome Powell will hold a press conference half an hour later to clarify related matters.

Tim Duy, the chief US economist at SGH Macro Advisors, believes that the current uncertainty may provide policymakers with more reasons to adopt a gradual rate cut strategy. He pointed out, "As we approach these projected limits, it is reasonable for the Fed to take a more cautious approach when assessing its position in the policy cycle."

In terms of interest rate decisions, the market widely expects the Fed to lower the benchmark interest rate by a quarter of a percentage point, bringing the federal funds rate to a target range of 4.25% to 4.5%. However, this interest rate level is far higher than the neutral rate level of 2.9% predicted by officials in September, indicating that policymakers are raising their estimates for this rate. This is also one of the reasons some policymakers tend to reduce the magnitude of rate cuts.

In terms of economic forecasts, recent data has shown that the economy is performing better than expected when officials last released their predictions. Therefore, policymakers may raise their economic outlook forecasts, indicating rising inflation rates, declining unemployment rates, and stronger economic growth.

The latest “dot plot” will show the expected path of interest rates, with officials anticipated to cut rates less frequently next year compared to the predictions made in September. However, these predictions have not yet fully reflected the policy impact of elected President Trump, as Fed officials are waiting for more policy details. Some Fed officials have pointed out that they need to wait for more detailed information from the Trump administration regarding tariffs and deportation policies to incorporate these policy factors into models for forecasting economic growth and inflation.

According to a survey by Bloomberg News, most economists predict that officials will implement three rate cuts next year, a reduction of one from policymakers' predictions in September.

Anna Wong, Chief Economist for the USA at Bloomberg, commented: “Given the expected weak core PCE inflation data for November—despite this data being officially released on December 20, Federal Reserve staff have been able to make highly accurate forecasts based on CPI and PPI data—this may have prompted some Federal Reserve officials, who were originally concerned about inflationary risks, to shift their views and reluctantly accept the decision to lower interest rates again.

In terms of the statement, Federal Reserve officials may retain a declaration similar to that of November, stating that the risks to achieving employment and inflation targets are 'roughly balanced.' However, it is also possible to add some wording indicating that they expect to 'gradually' reduce interest rates or suggest that a pause in rate cuts may be imminent. Economists at Barclays believe that after the rate cut this week, the Federal Reserve might keep rates unchanged in January and convey this message through relevant wording.

At the press conference, Federal Reserve Chair Powell may explain in detail how officials interpret economic data and its impact on policy. He may be asked when a pause in rate cuts might occur and whether this pause could come in January.

Investors will closely monitor any insights officials provide regarding future policy steps. Additionally, Powell may face questions about whether the central bank's progress toward achieving its inflation target has stalled and whether the current employment outlook is more optimistic.

2025 Action Path Focus

Currently, investors widely expect the Federal Reserve to make its final rate cut this Wednesday, but the market is more focused on whether the Federal Reserve will adjust its policy action expectations for 2025. All eyes will be on the Federal Reserve's 'dot plot,' a chart updated quarterly that shows each official's forecast for the federal funds rate trajectory. With the instability of various inflation data and cautious statements from Federal Reserve officials, the 2025 policy forecast is highly questioned. Meanwhile, the new policies from the Trump administration may also pose additional challenges for central bank decision-makers.

In September, the Federal Reserve made its first rate cut in over four years. At that time, the dot plot indicated a consensus among Federal Reserve officials that two more rate cuts were expected in 2024, with four smaller additional cuts anticipated in 2025. However, the current economic situation has changed significantly.

Former Cleveland Federal Reserve Bank President Loretta Mester stated that the previous forecast of four rate cuts next year needs to be 'reconsidered' and predicted that the economy will 'slow down' in 2025. She believes that two to three rate cuts in 2025 would be reasonable.

However, Luke Tilley, the chief economist at Wilmington Trust, holds a different view, believing that Federal Reserve officials will stick to their prediction of four rate cuts in 2025 as overall inflation is expected to decline.

Federal Reserve Chairman Jerome Powell left room for necessary policy adjustments in early December, noting that 'we can be more cautious' because economic performance at the beginning of the fall exceeded expectations. However, some economists were surprised by two unexpected developments at the end of 2024, which may lead to a retreat from expectations.

First, the labor market has not shown any new signs of weakness. Second, the inflation data in the fall remains stubbornly stagnant, failing to approach the 2% target set by the Federal Reserve.

The latest evidence comes from the inflation data released by the USA Bureau of Labor Statistics last week, showing that the Consumer Price Index (CPI) rose 2.7% year-on-year in November, slightly higher than October's 2.6%. Meanwhile, the 'core' CPI, which excludes food and Energy price fluctuations, has risen 3.3% year-on-year in November for the fourth consecutive month, with an unexpected increase in wholesale prices in November exceeding market expectations, further intensifying inflationary pressures. These data further raised market expectations for a Federal Reserve rate cut this week, increasing the probability to over 95%.

There are differing views among officials, with inflation and employment being the focus.

Regarding whether the Federal Reserve will make adjustments to its economic outlook for 2025, some individuals hold a reserved attitude. Tilly from Wilmington Trust is one of them, believing that after the dot plot releases on Wednesday, the predicted range for the midpoint interest rate by the end of 2025 will remain between 3.25% and 3.5%.

Tilly pointed out that while Federal Reserve officials acknowledge that recent inflation data remains high, they must also closely monitor the dynamics of the labor market. Despite considerable market volatility, there is an overall trend of slowdown. Compared to most members within the Federal Reserve, Tilly has greater concerns about the employment market. He believes that due to a weak labor market, the risk of economic recession is as high as 35%.

Tilly further emphasized that labor demand is gradually declining, and the private sector's job growth is currently below the average level of the past six months, amounting to only 108,000 positions. He predicts that future growth in the labor market will further slow to nearly 100,000 new jobs per month.

Similarly, as an observer of the Federal Reserve, Wilmington Trust’s bond portfolio manager, Wilmer Stith, holds a different view. He believes that the Federal Reserve is still likely to implement four rate cuts next year.

Stith expects that at Wednesday's meeting, Powell will indicate that the Federal Reserve is making bullish signals in controlling inflation and point out that housing prices and other components of the CPI are moving towards the target. He emphasized: "This undoubtedly serves as a positive signal for the statement that 'we are getting closer to our goal.'"

As for the measures proposed at this Wednesday's meeting, Stith stated: "I believe that a 25 basis point rate cut is almost a done deal."

In addition, some Federal Reserve officials have expressed optimistic expectations regarding the inflation outlook. In mid-November, Richmond Federal Reserve President Tom Barkin predicted that the inflation rate would continue to decline next year.

Bajing attributes the stable performance of recent core inflation data to a more stringent comparison benchmark compared to last year. He expects that due to the high inflation data in the first quarter of this year, the inflation data for the first quarter of 2025 may be more optimistic, a change that once prompted officials to reassess the inflation situation.

Similarly, Chicago Federal Reserve President Austan Goolsbee also called for a broader perspective in his speech early in December. He pointed out that since the inflation rate peaked at 9% in 2022, it has significantly decreased, reaching a new high since 1981 at that time. Goolsbee added, "I still firmly believe that we will achieve the 2% inflation target."

However, Cleveland Federal Reserve President Mester expressed a different view in an interview. She believes that the latest data, including the CPI released last week, is sufficient to prompt Federal Reserve officials to reassess the policy path for 2025.

Mester stated, "I think people need to reconsider the appropriate policy direction for next year, even without considering the uncertain fiscal policy actions in the future, but we know those actions will happen sooner or later."

She further pointed out that, although interest rate cuts this week are still possible due to market expectations, a pause in cuts could occur in January. Mester believes, "They are more likely to complete the rate cut operations in December and then plan for next year's policy."

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