Federal Reserve Concludes Year with Third Rate Cut Amid Rising Inflation Concerns
The Federal Reserve has reduced interest rates by 25 basis points, concluding the year with a total of three rate cuts amounting to a 1% easing. This adjustment brings the federal funds rate to 4.25%. The Summary of Economic Projections indicates a median forecast of two rate cuts next year, alongside an upward revision of the year-end inflation projection for 2025 to 2.5%.
Policy makers appear to have underestimated inflation risks in recent years. Since the early price increases in 2021, the Federal Open Market Committee (FOMC) has primarily focused on its preferred measure, core PCE inflation. By 2022, their stance became more cautious than inflation data warranted. This caution eased in September, as only three FOMC members then perceived upside risks to core PCE inflation.
However, inflation concerns have resurfaced. The number of FOMC members recognizing upside risks to core PCE rose sharply from three to 15, marking the largest meeting-by-meeting increase since 2017. The median inflation forecast for 2024 also rose from 2.1% to 2.5%. This upward revision, combined with dissent from Cleveland Fed President Beth Hammack and heightened inflation risk perception, sets the stage for a potential pause in rate adjustments at January’s meeting. Investors interpreted this meeting as a hawkish signal despite the rate cut.
Euro Slips Below $1.04 as Fed’s Hawkish Cut Rattles Markets
The euro dropped below the critical $1.04 support interbank (IB) level for only the second time this year after the Federal Reserve delivered a hawkish rate cut yesterday evening. The move unsettled global equity markets, with investors reacting to the possibility of a more cautious stance from the US central bank, resulting in widespread losses across major indices.
The VIX, a key measure of implied stock market volatility, surged, doubling its level after the Fed meeting and setting up for its largest weekly increase since the pandemic. Market attention now shifts to central bank decisions in Norway, Sweden, the UK, Mexico, Taiwan, and the Philippines, with investors watching closely for any ripple effects from the Fed's policy shift.
As anticipated, the euro’s movements remain closely tied to US developments. Following the Fed’s decision, markets are now bracing for tomorrow’s US inflation data. Meanwhile, today’s GfK consumer survey from Germany failed to lift spirits, as consumer confidence remained in negative territory for December—a trend persisting since late 2021.
Bank of England Expected to Hold Rates Steady Amid Inflation Concerns
The Bank of England (BoE) is anticipated to leave the Bank Rate unchanged at 4.75% today, aligning with consensus expectations and market forecasts. Investors will focus on the vote split and any forward guidance, particularly whether the BoE hints at a potential rate cut in February or adopts a more cautious stance, akin to the Federal Reserve, in response to unexpected wage growth.
The Monetary Policy Committee has signalled a measured approach to policy easing, interpreted as quarterly rate cuts, which are likely to extend into 2025 given that economic data aligns with their projections. However, this week’s strong UK wage growth and persistent inflation have tempered market expectations, reducing anticipated rate cuts next year to fewer than two 25-basis-point reductions. UK gilt yields are approaching one-month highs, with the UK-German 10-year spread reaching levels last seen in the 1990s, pushing GBP/EUR past the €1.21 IB mark.
Meanwhile, GBP/USD is edging closer to the $1.26 IB level after the Fed’s hawkish decision last night. The pair experienced its steepest decline in over a month and remains in a downtrend since peaking at $1.34 at IB in late September. A hawkish tone from the BoE today could offer some relief, though short-term prospects for GBP/USD remain uncertain.
