December US interest rate cut likely as focus turns to next year

Markets widely anticipate the Federal Reserve to cut US interest rates later this month, with officials' concerns on inflation expected to affect the pace of reducing policy next year.

Recent rate-cut optimism stems from Friday's US unemployment report, which showed that employers added a more-than-expected 227,000 jobs in November while the unemployment rate edged higher to 4.2 per cent, in line with expectations.

Despite a surge in employment, the rise in the unemployment rate and underlying data showed signs that the labour market is cooling, giving the Fed the motivation to cut rates this month.

Odds of a 25-basis point jumped following Friday's release to 87 per cent, up from 66 per cent the same time last week, according to data from the CME Group. Doing so would reduce the Fed's target range to 4.25 to 4.50 per cent, a full percentage lower since they began cutting rates in September.

Any monetary policy activity from the Federal Open Market Committee (FOMC) is expected to be mirrored by most central banks in the Gulf Co-operation Council, which follow the Fed's decisions due to currency pegs.

Economists and Fed officials generally note, however, that the rate-decision picture could change depending on hotter-than-expected inflation data. Two inflation reports are due to be released before the Fed's next meeting.

“But barring a major surprise, the FOMC is on course to cut rates once more before the year is out,” Wells Fargo economists Sarah House and Michael Pugliese wrote to clients.

Fed officials favour cautious approach

In various speaking engagements this week, several Fed officials said they favoured a gradual approach to cutting interest rates.

Fed Governor Christopher Waller gave the clearest indication of where the central bank currently stands, saying in remarks at the George Washington University on Monday that “at present I lean towards supporting” cutting rates this month. The Fed has generally moved in unanimity in recent years on monetary policy decisions.

With a December rate cut at present seen as a near-guarantee, officials and markets are turning their attention towards next year. Much of that attention remains on inflation, which has run hotter-than-expected in recent months.

“While I am pleased at how well the labour market has held up under restrictive monetary policy, I am less pleased about what the data have been telling us the past couple of months about inflation,” Mr Waller said, noting that progress on taming inflation could be “stalling”.

The Fed's preferred inflation metric rose to 2.3 per cent on an annual basis in October, up from 2.1 per cent the month before, while core inflation also rose to 2.8 per cent.

While that inflation data does not indicate a pause in easing in December, it could mean the Fed eases at a “slower pace in 2025”, Derek Tang, economist at the LHMeyer analytics firm in Washington, wrote in a note to clients.

CME Group data on Friday showed markets are anticipating two quarter-point cuts next year, anticipating higher rates likely due to the policies of the incoming Donald Trump administration.

In the run-up to the 2024 election, Mr Trump ran on policies including a mass deportation of immigrants, universal tariffs and an extension of his tax cuts that economists generally argue will increase inflation.

During a moderated session in New York on Wednesday, Fed Chair Jerome Powell said the uncertainty of Mr Trump's policies means it is too early for them to be factored into the Fed's outlook.

“Here's what we don't know about tariffs. We don't know how big they'll be. We don't know their timing and their duration. We don't know what goods will be tariff. We don't know what country's goods will be tariff. We don't know how that will play into prices, what will be the transmission into prices,” he said at the DealBook Summit.

The Fed chair also said the central bank can afford to be “a little more cautious” in its approach to cutting interest rates, owing to the strength of the US economy.

“The economy is strong, and it's stronger than we thought it was going to be in September,” he said.

Meanwhile, Fed Governor Michelle Bowman, the final official to speak before the Fed's self-imposed blackout period begins, said that inflation remains “uncomfortably” high.

“I would prefer that we proceed cautiously and gradually in lowering the policy rate as inflation remains elevated,” Ms Bowman said during a moderated discussion at the Missouri Bankers Association Executive Management on Friday.

Ms Bowman also said she believes the so-called neutral rate – the level at which interest rates are neither restricting nor stimulating the economy – has edged up. Considered to be one of the more hawkish members on the FOMC, Ms Bowman warned cutting rates too quickly could reignite inflation.

The Fed's blackout period – the window in which officials are prohibited from publicly speaking on monetary policy – begins on Saturday and runs through December 19.

The Fed is also due to release its updated economic projections and outlook for monetary policy at the conclusion of its December meeting.