US Federal Reserve Cuts Interest Rates For Third Time, Dials Back 2025 Outlook

The central bank projected just two rate cuts in 2025, half the number forecast in September. This reflects a shift in outlook as policymakers grapple with recent inflation data and robust economic growth.

The Dow Jones Industrial Average responded sharply to the announcement, plunging 1,123 points as investors digested the prospects of higher rates for longer than previously anticipated.

Fed Chair Jerome Powell acknowledged the central bank’s progress in taming inflation, which has dropped from 5.6 per cent to 2.8 per cent since 2022, but expressed concern about recent trends. “Inflation has been moving sideways,” Powell told reporters at a post-meeting news conference on Wednesday. “The journey toward the Fed’s 2 per cent inflation goal has kind of fallen apart as we approach the end of the year.”

The decision came against a backdrop of mixed economic signals, with the US economy expanding at a healthy 2.8 per cent annual rate in the third quarter and job creation remaining robust, as evidenced by November’s addition of 227,000 payrolls.

Market analysts suggest the rate cut could have significant implications across various asset classes. Srijan Katyal, Global Head of Strategy & Client Services at ADSS, noted that the decision “displays the confidence the Fed has that elevated levels of inflation are not overly concerning.”

According to Katyal, the rate reduction could further boost risk assets, particularly benefiting small-cap stocks that have lagged behind technology shares. “The Russell 2000, up 15 per cent year-to-date, may find some respite and recoup some of the losses seen this month,” he said, noting the index’s nearly 4 per cent decline in December compared to Nasdaq’s 5 per cent gain.

The Fed’s updated economic projections paint a picture of sustained growth with potential inflationary pressures. Officials raised their 2024 GDP growth forecast to 2.5 per cent, up from the previous 2 per cent estimate, while core PCE inflation is expected to hold at 2.8 per cent this year.

The decision faced internal dissent, with Beth Hammack, head of the Federal Reserve Bank of Cleveland, voting against the rate cut, preferring to maintain current rates.

Looking ahead to 2025, the Fed now estimates the federal funds rate will drop to a range of 3.75 per cent to 4 per cent by year-end, marking a significant shift from earlier projections. The central bank also revised its estimate of the neutral rate—the rate that neither stimulates nor restricts economic growth—upward from 2.9 per cent to 3 per cent.

Katyal suggested the rate cut could pressure the US dollar, potentially benefiting other currencies. “Australian and New Zealand Dollar, that have dipped over 8.5 per cent against the United States Dollar this quarter, could be the one to look out for,” he said, despite recent rate cuts in these countries.

The move comes as President-elect Donald Trump‘s proposed policies on tariffs, immigration, and tax cuts add another layer of uncertainty to the economic outlook, though Powell emphasised it was “very premature” to draw conclusions about potential policy impacts.