Fed Reduces GDP Estimates and QT

Meeting Highlights 

• As widely anticipated the Fed held the target rate range to 4.25% – 4.50%.  The updated rate forecast, or dot plot, sees 50bps in rate cuts in 2025, same as the December forecast, but only two members see more than two cuts while in December five members saw three or more cuts. Two 25bps cuts would put the year-end 2025 rate at 3.875%. The 50bps expectation of cuts in 2025 is generally at the market consensus so no surprises there. The vote was unanimous on the rate decision while Fed Governor dissented on the decision to reduce QT.

 

• There were modest changes to the statement with less certainty on economic growth. The major change was from, “The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance” to “Uncertainty around the economic outlook has increased.” They also voted to slow QT from $25 billion per month in Treasuries to $5 billion while maintaining the MBS cap at $35 billion. The full side-by-side statement comparison is attached.

 

• Futures pricing prior to the announcement had 55bps of cuts for 2025. After the updated dot plot projections, the futures market continues to price about two 25bps rate cuts for this year (59bps).  Given the uncertainties that still abound around fiscal policies, the 2026 projections are little changed from the December forecast at two more 25bps rate cuts, but those will obviously be subject to intervening events.

 

• The long-run dot, or neutral rate estimate, was kept at 3.00% after being nudged from 2.50% to 3.00% during 2024. The increase in the so-called neutral rate over the past year, it had been at 2.50% since 2019 prior to last year’s adjustments, is a recognition that the post-pandemic economy is at a higher cost plateau than pre-Covid. It’s a little surprising it wasn’t nudged higher given the potential higher costs from proposed fiscal policies (read tariffs). Think of the neutral rate as the eventual destination of the Fed’s rate-cutting cycle. It should be noted that the range of estimates remains quite wide with a high of 3.875% and a low of 2.50%. It would have taken just one estimate to be lifted above 3.00% to move the median 1/8^th higher, so it was a close call. That is identical to the December dot plot.

 

• On GDP, the Fed has it at 1.7% for 2025 vs. 2.1% in the December forecast. One could see that large GDP adjustment coming as the Atlanta Fed’s GDPNow model is forecasting -1.75% for the first quarter. The pace is expected to improve slightly to 1.8% in 2026 and 2027, These levels are slightly below the December forecast and recognition of the expectation of lower growth.

 

• On inflation, after the improving inflation picture during the summer, progress stalled somewhat in the final quarter of 2024. With the possible higher cost fiscal policies, the Fed has upped its inflation forecast from December. For year-end 2025 core PCE is forecast now at 2.7% vs. 2.5% in the December forecast. We are currently at 2.6%. The 2026 forecast was  kept at 2.2% then dropping to the 2.0% target in 2027, both identical to the December forecast.

 

• As for the labor market, the Fed’s new forecast is for the unemployment rate to be 4.4% at year-end 2025 vs. 4.3% in the December meeting. That’s a recognition that slower growth expectations will cause the unemployment rate to rise. We are currently at 4.1%.  For 2026 and 2027 the unemployment rate is also forecast at 4.3%, unchanged from the December forecast.

 

• Overall, today’s report kept with the expectation of two rate cuts in 2025 but significantly reduced expected GDP growth with a commiserate increase in unemployment and a slightly more grudging increase in inflation. They also moved to reduce QT by cutting the redemption level of Treasury securities from $25 billion per month to $5 billion. The forecasts are not far from market expectations which accounts for the rather docile reaction in the markets with Treasuries rallying and equities managing to hold pre-release gains. One surprise we have is the stable neutral rate at 3.00%, but the range of estimates remains wide, so it was perhaps more a matter of lucky math that the estimate didn’t move at this meeting.

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Updated Dot Plot – Expected Rate Cuts in 2025 Remain at 50bps

Source: Bloomberg

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