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Midweek Update: Economic Indicators, Fed Guidance, and Inflation Outlook

Federal Reserve officials are set to announce later today their final decision on whether to lower borrowing costs for the third consecutive time this year. Among both traders and economists, there is a broad consensus that a quarter-point cut is likely. Additionally, the Fed is expected to signal fewer rate cuts for next year than previously anticipated.

midweek-update-18-december-2024

The U.S. economy has proven more resilient than Fed officials projected in their September forecasts. Back then, the median estimates for 2024 pointed to 2% growth, core inflation at 2.6%, and unemployment at 4.4%. However, inflation has not eased as much as expected, the labor market has not weakened as feared, and the economy has grown at a much stronger pace.


As a result, the current outlook suggests policymakers may revise their 2025 projections to reflect higher inflation, lower unemployment, and stronger economic growth.


The centerpiece of the updated forecasts, however, will be the Fed's "dot plot," which outlines officials' rate-cut expectations for next year. According to a Bloomberg survey of economists, the majority anticipate three quarter-point cuts in 2024—fewer than the four cuts projected in the Fed's September dot plot.


Goldman Sachs economists predict the Fed will lower the federal funds target rate by a quarter-point each in March, June, and September, bringing it down to a range of 3.5%-3.75%.


Meanwhile, swap market traders are pricing in a slightly more cautious path, expecting about two quarter-point cuts. This pricing reflects recent data suggesting a pause in inflation progress and a labor market that remains robust. Additionally, traders are concerned that inflation could accelerate further under Donald Trump's administration.


On the other hand, some bond traders believe the market's outlook is overly hawkish and foresee deeper easing, with the target rate falling to 3.375% next year. Their perspective is fueled by potential vulnerabilities in the labor market.


Chair Jerome Powell is expected to provide forward guidance during the press conference following the decision. Powell will likely face tough questions about the potential impact of the Trump administration on the economy.


Last month, when asked similar questions, he responded, "We don't guess, we don't speculate, and we don't assume." However, with progress on inflation already stalling, it will be challenging for officials to avoid addressing the risks of higher inflation.


The economic impact of President-elect Trump's anticipated policies remains uncertain, complicating market expectations. However, most forecasts point toward higher inflation and growth, with the labor market expected to remain robust.


Economists surveyed by Bloomberg project that the core personal consumption expenditures (PCE) price index will average 2.5% next year, up from the 2.3% forecast a month ago. Payroll growth estimates remain largely unchanged at an average of 121,000, while growth projections have been revised upward to 2.1%.


Given this backdrop, there is a strong belief that the Fed will signal a gradual approach for the coming year. Economists from ING Group, Franklin Templeton, and JPMorgan predict that the yield on the U.S. 10-year benchmark Treasury could rise to 5%–5.5% in the first quarter of next year.


Some peers, such as T. Rowe Price, suggest yields could climb as high as 6%. Therefore, if Fed officials signal less easing in the future as expected, a stronger U.S. dollar is likely.


Lastly, data released this week ahead of the year's final Fed meeting presented a mixed picture. U.S. services activity expanded at its fastest pace since October 2021. However, industrial production unexpectedly weakened for the third consecutive month in November. Meanwhile, retail sales data indicated that consumer spending increased at a solid pace.


The nominal value of retail consumption rose by 0.7% in November, surpassing the 0.5% forecast. This increase was largely driven by higher auto demand following recent hurricanes. Excluding autos, retail sales grew by 0.2%. Additionally, retail consumption was supported by holiday shopping and front-loaded demand ahead of tariff-induced price increases.


Retail sales data is considered a leading indicator of inflation. However, traders will primarily focus on Friday's release of November's PCE price index for more detailed insights into the inflation trajectory.


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