Volkswacht Bodensee - US Fed signals fewer cuts, sending stocks tumbling

Policymakers voted 11-to-1 to lower the central bank's key lending rate to between 4.25 percent and 4.50 percent as expected, the Fed announced in a statement.

But they also halved the number of quarter-point cuts they expect next year, from an average of four back in September to just two on Wednesday, catching the markets by surprise.

All three major indices on Wall Street finished firmly lower, while the yields on US Treasurys surged as traders digested the prospect of higher interest rates over the next couple of years.

While inflation has "eased significantly," the level remains "somewhat elevated" compared to the Fed's long-term target of two percent, Chair Jerome Powell told reporters on Wednesday.

He said he remained "very optimistic" about the state of the US economy, adding that the Fed was now "significantly closer" to the end of its current easing cycle.

It was the final planned rate decision before outgoing Democratic President Joe Biden makes way for Republican Donald Trump, whose economic proposals include tariff hikes and the mass deportation of millions of undocumented workers.

The non-partisan Congressional Budget Office (CBO) estimates that imposing fresh tariffs would cut economic growth and push up inflation.

Following Trump's victory in November's election, some analysts had already pared back the number of rate cuts they expected in 2025, warning that the Fed may be forced to keep rates higher for longer.

- Inflation battle not over-

The Fed has made progress tackling inflation through interest rate hikes in the last two years without dealing a knockout blow to either growth or unemployment, and recently began cutting rates to boost demand in the economy and support the labor market.

But in past months, the Fed's favored inflation measure has ticked higher, moving away from the bank's target and raising concerns that the inflation fight is not over.

Members of the Fed's rate-setting Federal Open Market Committee (FOMC) now "need to see additional improvements in inflation to continue to cut rates -- full stop," KPMG chief economist Diane Swonk wrote in a note published after the decision.

- Higher growth, higher inflation -

In updated economic forecasts published alongside the rate decision, members of the 19-member FOMC penciled in just two quarter-point rate cuts in 2025, on average, halving the number of cuts they now expect.

They also hiked their outlook for headline US inflation next year to 2.5 percent, and do not see it returning to two percent before 2027.

In some good news for the world's largest economy, FOMC members raised their outlook for growth this year to 2.5 percent, and to 2.1 percent in 2025.

Policymakers expect the unemployment rate to be slightly lower this year than previously predicted at 4.2 percent, before ticking up slightly to 4.3 percent in 2025 and 2026 -- a figure at least one analyst said was overly optimistic.

"Rate cuts will come faster than the Fed expects, as unemployment tops the new forecast," Pantheon Macroeconomics chief US economist Samuel Tombs wrote in a note to clients published after the decision.

G.Haefliger--VB