StoneX Strategy: Expecting Fed to Hold the Line and Project Two Cuts For 2025, but Open a Door to Three

StoneX Strategy: Expecting Fed to Hold the Line and Project Two Cuts For 2025, but Open a Door to Three

From the desk of our senior advisor, Jon Hilsenrath.

Summary: The Fed will cut its benchmark interest rate a quarter percentage point Wednesday. Its policy statement will likely point toward modest weakening in the labor market and somewhat elevated inflation. Its interest rate projections will drift toward three rate cuts in 2025, but not enough to move the median away from two. In his press conference, Fed Chairman Jerome Powell will express vigilance on ensuring the labor market expansion continues and maintain his stance that decisions are being made on a meeting-by-meeting basis based on the data. The market expects three rate cuts in 2025. Powell and the Fed will notsay everything investors want to hear in that respect, but he will leave the door open to that path.

 

Options Open: Investors place about an 80% probability on the Fed cutting short-term rates three times before year-end, starting with its policy meeting this week. The Fed is unlikely to give investors all they want in terms of signaling at this week’s policy meeting. The central bank will cut its policy rate, as widely expected, to just above 4%, but its rate projections are likely to remain at two cuts by year-end. Fed Chairman Jerome Powell is likely to work to keep his options open in his post-meeting messaging.

The Summary of Economic Projections released by the Fed before the press conference encapsulates the challenge. The Fed’s June forecasts for 2025 look pretty good – the central bank is likely to stick to projections of near 3% inflation by year-end, a jobless rate at 4.5% and growth in economic output of 1.4%. Under those projected conditions back in June, only two of 19 officials penciled in three rate cuts by year-end; eight people penciled in two rate cuts, two people had one cut and seven had no cuts at all. It is hard to see how the consensus would shift to three rate cuts when the economic projections have not changed much for the year. We see a drift toward three rate cuts in the rate projections, given recent signs of labor market weakening, but not enough to shift the consensus away from two.

The policy statement will likely acknowledge deterioration in the job market. In July the Fed said, “The unemployment rate remains low, and labor market conditions remain solid.” The central bank cannot say that anymore. We expect the Fed to say something along the lines of what it said last year at this time: “Job gains have slowed and the unemployment rate has risen modestly.”

The Fed might justify moving pre-emptively, as insurance, to support the goal of maximum employment. However, inflation remains somewhat elevated, which the statement will note. Moreover, the Fed’s projections for inflation in 2026 are likely to rise. In June, officials projected inflation would recede to 2.4% in 2026. We expect the new projections to show inflation is expected to remain over 2.5% next year. It is hard to speed up rate cut projections when you’re also raising your inflation projections.

Powell will thus note that the Fed’s goals are in conflict. His press conference messaging is likely to emphasize vigilance to ensure sufficient demand to keep unemployment low and a willingness to act if the data suggest more aggressive rate reductions are warranted. But we doubt he is going to want to pre-commit to three rate cuts this year, given that the outlook is uncertain and the risks of higher inflation are nagging. Thus, he will likely stick to his line of decision-making on a meeting-by-meeting basis, and data dependence. He will leave a door open to three cuts this year, and thus another rate cut in October, but we think he would rather leave the meeting with market betting on an October rate cut closer to 50% than 100%.

As for 2026, given the weakening in the labor market, we expect the Fed to pencil in an additional rate cut in 2026, meaning two cuts to below 3.5%, and then one more in 2027 to under 3.25%, which would bring the rate near what the central bank considers to be neutral. It doesn’t go under 3% unless it sees recession. Of course, President Trump is calling for much lower rates, but this is not yet President Trump’s Fed, thus rate projections and economic forecasts won’t reflect his wishes.

We expect Powell to play his cards close to his vest on politics. He will stick to the line that the Fed will follow the courts and the law with regard to the Trump Administration’s efforts to remove Governor Lisa Cook from office. He might say a good word about Governor Cook’s character, but we doubt he will go into any specifics or positioning in the case. With regard to President Trump’s attacks on Fed policy, Powell will stick to his script and not engage, beyond stating the importance of Fed independence.

-- Author: John Hilsenrath, Senior Advisor