The Fed Is Unlikely To Cut Interest Rates In January Due To Inflation

The Federal Reserve cut interest rates by 0.25% on December 18 but an interest rate cut is unlikely when the Fed issues its next policy decision on January 29. Elevated levels of consumer inflation combined with the latest Federal Open Market Committee member forecasts of future interest rates imply a meeting without an interest rate policy change is unlikely to surprise market mavens and economists. However, the pace and timing of Fed rate cuts beyond January are less clear. Multiple interest rate cuts are likely in 2025—and perhaps more cuts than the latest FOMC projections suggest.

Fed Policy Is Likely To Be On Hold in January

On December 18, the Federal Reserve cut the federal funds rate by 0.25%, targeting a range between 4.25% and 4.50%, which was widely expected. A similar rate cut at the next Fed meeting on January 29 is unlikely.

With elevated U.S. consumer inflation rates and still low unemployment rates, the Fed is not under pressure to cut interest rates urgently. Plus, the December 2024 Fed statement was accompanied by FOMC projections that reflected only two likely 0.25% rate cuts in 2025. The previous September 2024 projections reflected expectations of four likely 0.25% rate cuts in 2025.

Understandably, the December FOMC projections dampened expectations for 2025 interest rate cuts.

The odds of a January 2025 Fed rate are now very slim. According to the CME FedWatch Tool, the chance of a Fed interest rate cut by 0.25% on January 29 was only 7.5% as of December 23 at 6:33 a.m. ET. Meanwhile, the odds of no change in Fed policy were at a very high 92.5%.

Inflation Is Holding Back Fed Rate Cuts

While rising year-on-year consumer inflation rates did not keep the Fed from cutting rates in December, the outlook for the January Fed meeting is different because year-on-year total CPI and core CPI rates are likely to accelerate further in the December CPI consumer inflation report that will be released in January.

November year-on-year consumer inflation rates are already elevated, with total Consumer Price Index at 2.7%, core CPI at 3.3%, total PCE inflation at 2.4%, and core PCE at 2.8%. Total year-on-year CPI and PCE consumer inflation rates are likely to fall to the Fed’s 2% target in 2025, but they are currently above target—and core inflation rates could remain above the Fed’s 2% for most or even all of 2025.

The elevated levels of inflation are most disconcerting because year-on-year total CPI has risen in the past two reports and it is likely to rise for a third month in a row in the December report that will be released on January 15—just two weeks before the next Fed decision.

With the December total CPI rate likely to be closer to 3%, it could send a worrisome signal to markets that the Fed is losing control of inflation. Even if the main factors behind a further acceleration in year-on-year inflation are base effects, the Fed would be hard-pressed to cut interest rates in that environment.

Fed Policy In 2025 Beyond January

Following a further acceleration in year-on-year December CPI consumer inflation, year-on-year consumer inflation rates would likely fall in the second quarter of 2025 due to base effects, according to Prestige Economics. This means that while markets may be correctly assessing the likelihood that the Fed will keep interest rates on hold in January, they may be underestimating the potential for more than two rate cuts in 2025.

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The latest FOMC projections were impacted by the recent acceleration in consumer inflation, which is likely to prove transitory with lower year-on-year inflation rates in Q2 2025. Despite the change in FOMC projections, Prestige Economics expects at least three rate cuts in 2025, with the next interest rate cut coming at or before the May 2025 Fed meeting.

Market Implications Of Fed Policy

Following the December Fed interest rate cut and FOMC projections, market expectations reflect no interest rate cut in January with fewer rate cuts in 2025 than previously expected. However, FOMC projections often differ greatly from reality—and there could be cause for the Fed to cut interest rates by more than 0.5% in 2025.

Because markets have now priced in the FOMC projections of only two 0.25% Fed rate cuts in 2025, any additional cuts would likely weigh on the dollar and bond yields, while supporting equity prices, bond prices, and industrial commodity prices.

What do you think the Fed will do in January 2025 and beyond?

Will the Fed only cut interest rates by 0.5% in 2025?

Let me know what you think in the comments below.

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