On a recent Wednesday, the Federal Reserve made a pivotal announcement, reducing interest rates by 25 basis points as anticipated by the market. However, this seemingly straightforward decision came with an unexpected twist: Fed officials significantly raised their median target range for future policy rates, alongside an upward adjustment in inflation expectations for the next couple of years. They indicated that there might only be two rate cuts next year, contrary to the hopes of many market participants.

During the press briefing, Jerome Powell, the Fed chairman, characterized the decision to lower rates as a "challenging" one. The Fed is tasked with the dual mandate of controlling inflation while promoting employment. Powell conveyed that the risks associated with these goals appear balanced at this moment, as significant progress has already been made in curbing inflation. Even with the cumulative 100 basis points in rate cuts to date, Powell noted that rates still "significantly" suppress economic activity, implying a continuing trajectory for future cuts. Yet, he emphasized the need for clearer evidence of inflation progress before any further adjustments could be made.

As Powell addressed the audience, he expressed confidence in the overall strength of the U.S. economy, citing substantial advancements over the last two years toward the Fed's objectives. While the labor market has cooled from its previously heated levels, it remains robust. The current inflation rate is edging closer to the Fed's long-term target of 2%.

In order to further fulfill its commitments to amalgamate employment support with inflation control, the Federal Open Market Committee opted to reduce the policy rate by 25 basis points, thereby easing restrictions. Additionally, there will be a continued decrease in the Fed's portfolio of securities, designed to stabilize the economy.

Powell highlighted recent economic indicators, suggesting that activity continues to expand at a solid rate. The U.S. GDP exhibited an annualized growth rate of 2.8% for the third quarter, mirroring the growth momentum seen in the second quarter. Consumer expenditure has remained robust, coupled with a strengthened investment in equipment and tangible assets. Conversely, the housing sector has shown signs of weakness, which could play into overall economic assessments moving forward.

An overarching improvement in supply conditions over the past year has buttressed the impressive performance of the U.S. economy. In the Economic Projections Summary (SEP), committee members generally forecast that GDP growth will maintain a solid pace over the coming years, with a median projection hovering around 2%.

When considering the labor market, Powell noted that indicators remain stable. In the past three months, an average of 173,000 non-farm jobs were created monthly, a slowdown compared to earlier in the year. While the unemployment rate has risen relative to last year, it settled at a respectable 4.2% in November, indicating a tight labor market by historical standards. Although nominal wage growth has somewhat decelerated, the gap between job openings and labor availability has decreased—pointing towards a more balanced labor dynamic.

Overall, a broad array of metrics suggests that the current tightness of the labor market is less severe than it was in 2019, indicating that it is no longer a significant source of inflationary pressure. The median forecast for the unemployment rate at the end of this year stands at 4.2%, with expectations for the forthcoming years hovering around 4.3%.

Turning to inflation, Powell remarked that while significant desensitization has occurred over the past two years, prices still slightly outpace the Fed's long-term objective of 2%. According to estimates derived from the Consumer Price Index (CPI) and other data, the total Personal Consumption Expenditures (PCE) price experienced a year-over-year rise of 2.5% ending in November, with the core PCE—which excludes food and energy—up by 2.8%.

Long-term inflation expectations appear to remain anchored, as indicated by surveys among households, businesses, and forecasters, alongside measures from financial markets. The median forecast for total PCE inflation is 2.4% for this year, nudging up to 2.5% next year, which is slightly higher than previous estimates. Following that, the projection tapers down towards the targeted 2%.

In summary, Powell conveyed that the risks associated with achieving both employment and inflation targets are roughly balanced, with particular focus on potential risks to these dual goals. He noted that the Fed is continuously adjusting its policies to a more neutral stance, enabling them to sustain the strength of the labor market and the economy, while laying the groundwork for further progress.

Through this recent interest rate cut, the Federal Reserve has lowered its policy rate by a total of 100 basis points from its peak, signaling a notable shift away from tight monetary policy. This change allows the Fed to adopt a more measured approach when contemplating future adjustments.

There is a clear understanding that overly rapid or significant cuts to policy restrictions could hinder improvements in inflation, whereas slowing the reduction too much might unnecessarily undermine economic activity and employment. As the committee evaluates further adjustments to the federal funds target range, they will take into account the most recent data, changes in economic outlook, and the balance of risks involved. There are no fixed paths set for policies—it remains a dynamic assessment.

In the SEP, participants documented their personal evaluations regarding the most suitable trajectory for the federal funds rate, based on what they believe to be likely future scenarios. The median prediction indicates that the appropriate level for the federal funds rate at the end of next year would be 3.9%, dropping to 3.4% by the end of 2026. These median estimates are slightly elevated from projections made in September, which aligns with the recent uptick in inflation forecasts.

Powell mentioned that if economic conditions continue to remain strong without further progression towards the 2% inflation target, the Fed may opt to slow its pace of policy adjustment. Conversely, should the labor market weaken unexpectedly or inflation decline more swiftly than anticipated, the Fed has the flexibility to ease policy more quickly. The Fed is prepared to navigate the risks and uncertainties that arise in the pursuit of these dual objectives.

Additionally, regarding technical adjustments, the Fed has lowered the overnight reverse repo rate to align with the lower bound of the target range, consistent with its typical configurations. Powell clarified that these technical changes will not shift the stance of monetary policy.

In a subsequent Q&A session, Powell reiterated that the decision to cut rates this month was challenging. He remarked that while current policies are less restrictive than previously, the prevailing rates are still “significantly” curtailing economic activity, indicating that the Fed is on a path of continued rate reductions. However, he underscored the necessity of observing further progress on inflation before taking additional rate-cutting measures.

Powell also responded to inquiries concerning potential ramifications of government tariff policies on Fed operations. He noted that a number of policymakers have begun to consider the potential effects of higher tariffs that could come into play. However, he also stressed that the implications of these policy proposals are currently uncertain. The Fed is engaged in modeling and assessment of these proposals, yet they haven’t been incorporated into current decision-making processes as the exact nature of these policies remains unclear.

“We have very little understanding of the actual policies at this stage,” he said. “Therefore, it is premature to draw any conclusions now.”