The Federal Reserve is likely to cut interest rates by 25 basis points this week, signaling caution regarding the pace of potential monetary policy easing going forward, Saxo Bank stated Monday. Markets widely expect the central bank's Federal Open Market Committee to deliver a quarter-percentage-point reduction in its benchmark lending rate Wednesday, as indicated by the CME FedWatch tool.
This would mark a second consecutive 25-basis-point decrease following a 50-basis-point reduction in September. Recent US consumer inflation data showed an easing in shelter cost growth, while the latest jobs report indicated an increase in the unemployment rate and a decline in labor force participation.
These factors are likely to prompt the FOMC to cut rates by 25 basis points later this week, as noted by Saxo Bank Chief Investment Strategist Charu Chanana in a report Monday. However, there's a growing chatter about policymakers potentially skipping a rate cut next month due to persistent inflation in certain sectors and continued economic resilience, as per the report.
"With the new Trump administration likely to focus on trade tariffs early on after taking office on January 20, there is risk that it could create upside risks to inflation, which could make the Fed more cautious about future cuts," Chanana indicated. The December rate decision will coincide with the FOMC's updated economic projections.
Revised estimates may suggest three or even two rate cuts next year, down from four projected in the previous iteration, amid elevated inflation risks, according to Saxo Bank. If the 2025 dot plot shows only two cuts, it would be described as a considerable hawkish surprise for the market, Chanana elaborated. The firm also anticipates that 2026 projections could indicate two rate cuts, reflecting a slower normalization path.
The updated Summary of Economic Projections is expected to reveal higher 2024 core inflation, as measured by personal consumption expenditures, along with lower unemployment and stronger economic growth than previously projected in September, according to the report. If the FOMC indicates fewer rate cuts next year than previously projected, risk assets such as equities may experience renewed volatility, Saxo Bank stated.
"A hawkish tone could exert downward pressure on equity valuations, particularly for growth stocks that are more sensitive to higher rates," Chanana mentioned. "Other interest rate-sensitive sectors, such as homebuilders and small-caps, might also encounter challenges. Investors may consider rotating into defensive sectors like utilities and consumer staples if the Fed suggests a slower pace of cuts.".