Fed Outlook 2025: A More Hawkish Fed Committee May Spark More Dissent

As we step into 2025, the recent Federal Open Market Committee (FOMC) meeting has sent ripples through global markets. Last Wednesday's meeting not only raised the inflation outlook but also signaled a restrained approach to rate cuts, leaving investors scrambling to evaluate its potential impacts on the financial landscape.

During the December FOMC meeting, Jerome Powell's hawkish stance directly led to a reevaluation of the projected interest rate path for 2025. These adjustments in market expectations have triggered significant turbulence in both equity and bond markets.

Beyond the FOMC's decision to lower the target range for the federal funds rate by 25 basis points (bps), the Federal Reserve's meeting conveyed several critical pieces of information:

– Federal Funds Rate: Reduced by 25 bps to a target range of 4.25–4.50%

– Overnight Reverse Repurchase Agreement (ON RRP): Lowered by 30 bps

– Mandate Reinforcement: The Fed reinstated its dual mandate focusing on inflation and employment

– Committee Voting: Cleveland Fed Chair Beth M. Hammack voted to maintain the target range

Despite the expected rate cut, Jerome Powell indicated that further reductions depend on the trajectory of persistently high inflation, suggesting a potential pause in rate cuts in January 2025.

In response to the FOMC's projections, major financial institutions have adjusted their expectations for 2025. According to dot plot analysis, the consensus among prominent banks predicts 2 to 3 rate cuts, amounting to a total of 50 to 75 basis points over the year. Meanwhile, Deutsche Bank suggests a possible pause in rate adjustments as early as January, leading to an extended hold throughout the year. Others like Nomura and RBC anticipate only 1 rate cut with 25 basis points.

Looking ahead to the 2025 FOMC meetings, a set of more hawkish Federal Reserve regional bank presidents will join the voting panel, potentially leading to greater dissent regarding federal rate cuts compared to those seen in December.

Although Beth M. Hammack will rotate off the voting panel in 2025, replaced by the more dovish Chicago Fed President Austin Goolsbee, the other two substitutes—St. Louis Fed President Alberto Musalem and Kansas City Fed President Jeffrey Schmid—are decidedly more stringent on policy, imparting a hawkish tone to the 2025 rate path.

Both Musalem and Schmid have signaled a more hawkish stance. Musalem remarked in early December, "The time may have come for pausing the easing cycle."

Oscar Munoz, an analyst from TD Securities, commented on the panel rotation, stating, "It opens up the door to more dissenting votes next year."

The Trump 2.0 policy remains a pivotal element in macroeconomic and market dynamics, as most of these policies naturally exhibit inflationary traits, raising the likelihood of increased inflation, which could restrict the Federal Reserve's ability to lower interest rates. Concurrently, U.S. stocks may encounter valuation compression due to the limited scope for further rate cuts and rising Treasury yields. This situation calls for cautious investment strategies, especially with stock valuations near their peak.

Despite these challenges, corporate earnings remain a key support for equity market resilience. Market sentiment currently favors a soft landing for the U.S. economy as rate cuts begin, likely boosting earnings further, with additional support from President Trump's tax and industrial policies.

J.P. Morgan's chief global strategist, Dr. David Kelly, urges investors to "read between the lines" in the face of high equity concentrations and valuations. Despite a climb in long-term Treasury yields, Dr. Kelly highlights investment opportunities in undervalued stocks, fixed income, and international markets.

UBS projects moderation in inflationary pressures and advises investors to "use any near-term turbulence to add to US stocks". The bank advocates portfolio diversification, anticipating the strongest annual performance in US stock market since the early 2000s, potentially underpinned by a continuation of Trump's policies.