December 31, 2024      

     The U.S. economy appears to be finishing 2024 with an often anticipated, yet rarely delivered, soft landing. The labor market and the consumer proved to be more resilient than previously thought, but challenges lie ahead. As to inflation, the Fed can’t say ‘Mission Accomplished’ as recent data indicates progress on disinflation has stalled above the Federal Open Market Committee’s (FOMC) 2% goal. That did not prevent the central bank lowering policy rates by 25 basis points at its December 17-18 meeting, but it did adopt a more cautious approach in cutting rates in 2025.

    While the FOMC lowered the targeted fed funds range to 4.25-4.50% as expected, Fed Chairman Powell hinted there may be a pause in rate cuts as we move into 2025 and the pace of easing will likely slow. The Summary of Economic Projections (SEP), specifically the ‘dot plot’ show a median forecast of 50 basis points of rate cuts in 2025, versus September’s median projection of 100 basis points of cuts next year. The change in the forecast can largely be attributed to the SEP as the projections for GDP and core PCE Deflator were raised upward. Additionally, after three consecutive rate cuts totaling 100 basis points the Fed is very much aware that monetary policy operates with long and variable lags, and it may just be time to stop and look around for a little while. Finally, the outlook for 2025 is riddled with uncertainty.

        Overall, the economy remains on decent footing. Inflation has been held up by demand. The underlying fundamentals of the American consumer appeared to end 2024 looking solid, but caution is starting to spread across certain income distributions. Middle and higher income shoppers seem to be emulating lower income customers by economizing on quality and quantity. Rising auto and credit card delinquencies may also be foreshadowing a faltering in consumer momentum. There is also a growing divergence characterized by growth in services and deterioration in manufacturing. Broad labor market indicators are consistent with an ongoing cooling in the labor market. Hiring rates are low, causing the duration of unemployment to rise and the wage premium associated with switching jobs has come down.

     Uncertainty on growth and inflationary impacts of policy shifts from the new administration, and the fact that by Powell’s own admission rates are getting closer to neutral, provides plenty of reason for the Fed to be cautious going forward. Officials have been trying to do a balancing act. They don’t want to undo the progress of bringing inflation down by cutting rates too fast, or too deep. On the other hand, they don’t want to keep rates restrictive for too long, unnecessarily cooling down economic activity. In sum, it comes down to a tug of war between unemployment and inflation. If unemployment rises the Fed will cut more aggressively. If inflation becomes increasingly sticky and problematic the Fed will further pause or suspend cuts. Should both happen, and the financial markets get a whiff of stagflation, the real fireworks will commence!