The Federal Reserve cuts rates again but divisions deepen, next year's path may become more conservative

Original Title: "A 'Hawkish Rate Cut' That’s Not So 'Hawkish', and Balance Sheet Expansion That’s 'Not QE'"

Original Authors: Li Dan, Zhao Yuhe, Wallstreetcn

The Federal Reserve, as the market expected, cut rates again at a regular pace, but revealed the biggest internal split among voting policymakers in six years, suggesting it will slow its actions next year and may not act in the near term. As Wall Street insiders anticipated, the Fed also launched reserve management, deciding to buy short-term Treasuries at year-end to address pressures in the money market.

On Wednesday, December 10, Eastern Time, after the FOMC meeting, the Federal Reserve announced that the target range for the federal funds rate would be lowered from 3.75%-4.00% to 3.50%-3.75%. This is the third 25 basis point rate cut this year. Notably, this is the first time since 2019 that the Fed’s rate decision has faced three dissenting votes.

The dot plot released after the meeting shows that the Fed policymakers’ rate path forecast is consistent with the dot plot released three months ago, still expecting one 25 basis point rate cut next year. This means that the pace of rate cuts next year will slow significantly compared to this year.

By the close of trading on Tuesday, CME tools showed that the futures market expected an almost 88% probability of a 25 basis point rate cut this week, while the probability of another 25 basis point cut would not reach 71% until June next year; for the meetings in January, March, and April next year, the probability of such a cut did not exceed 50%.

The above CME tool forecasts can be summarized by the recently popular term "hawkish rate cut." This means that the Fed will cut rates this time, but at the same time signals a possible pause in action, with no further cuts in the near future.

Nick Timiraos, a senior Fed reporter known as the "new Fed wire service," wrote after the meeting that the Fed "hinted it may not cut rates again for now" because there is a "rare" split internally over whether inflation or the labor market is more concerning.

Timiraos pointed out that three officials dissented from the 25 basis point rate cut at this meeting, and the stagnation in inflation decline and cooling labor market made this meeting the most divided in recent years.

At the post-meeting press conference, Powell emphasized that he does not believe "the next move will be a rate hike" is anyone’s baseline assumption. The current rate level allows the Fed to wait patiently and observe how the economy evolves. He also said that the available data indicate the economic outlook has not changed, and the scale of Treasury purchases may remain high in the coming months.

01 Fed Cuts Rates by 25 Basis Points as Expected, Still Expects One Cut Next Year, Launches RMP to Buy $40 Billion in Short-Term Treasuries

On Wednesday, December 10, Eastern Time, after the FOMC meeting, the Federal Reserve announced that the target range for the federal funds rate would be lowered from 3.75%-4.00% to 3.50%-3.75%. This marks the third consecutive FOMC meeting with a 25 basis point rate cut, totaling a 75 basis point reduction this year, and a cumulative 175 basis point cut since September last year in this round of easing.

Notably, this is the first time since 2019 that the Fed’s rate decision has faced three dissenting votes. Governor Milan, appointed by Trump, continued to advocate for a 50 basis point cut, two regional Fed presidents and four non-voting members supported holding steady, making a total of seven dissenters, reportedly the largest split in 37 years.

Another major change in this meeting’s statement compared to the last is in the rate guidance. Although a rate cut was decided, the statement no longer generally says that the FOMC will assess future data, ongoing changes in outlook, and risk balance when considering further cuts, but rather more specifically considers the "magnitude and timing" of cuts. The statement now says:

"In considering the magnitude and timing of any further adjustments to the target range for the federal funds rate, the (FOMC) Committee will carefully assess the latest data, evolving (economic) outlook, and risk balance."

The statement reiterated that inflation remains slightly elevated and that downside risks to employment have increased in recent months, deleting the phrase "unemployment rate remains low" and noting a slight rise as of September.

The addition of "magnitude and timing" in considering further rate cuts is seen as signaling a higher threshold for cuts.

Another important change in this meeting’s statement compared to the last is the addition of a paragraph specifically noting the purchase of short-term Treasuries to maintain ample reserves in the banking system. The statement reads:

"The (FOMC) Committee judges that reserve balances have declined to an ample level and will begin purchasing short-term Treasury securities as needed to maintain ample reserve supply."

This effectively announces the launch of so-called reserve management, rebuilding a liquidity buffer for the money market. Year-end often sees market turmoil, as banks typically reduce repo market activity at year-end to support their balance sheets for regulatory and tax settlements.

The statement says reserves have declined to an ample level, and to maintain ample reserves, short-term Treasury purchases will begin this Friday. The New York Fed plans to buy $40 billion in short-term Treasuries over the next 30 days, and reserve management purchases (RMP) of short-term Treasuries are expected to remain high in the first quarter of next year.

The median of Fed officials’ rate forecasts released after Wednesday’s meeting shows that their expectations are exactly the same as the last forecast released in September.

Fed officials currently also expect that after three rate cuts this year, there will be about one 25 basis point rate cut each in the next two years.

Previously, many expected that the dot plot would show Fed officials leaning more hawkish on future rate changes. This time, the dot plot is actually more dovish compared to the last one.

Among the 19 Fed officials who provided forecasts, seven expect rates to be between 3.5% and 4.0% next year, compared to eight last time. This means that one fewer official expects no rate cut next year compared to last time.

The economic outlook released after the meeting shows that Fed officials raised their GDP growth expectations for this year and the next three years, and slightly lowered the unemployment rate forecast for 2027, i.e., the year after next, by 0.1 percentage points, with forecasts for other years unchanged. This adjustment shows the Fed sees the labor market as more resilient.

At the same time, Fed officials slightly lowered their PCE inflation and core PCE inflation forecasts for this year and next year by 0.1 percentage points each. This reflects a slightly increased confidence in inflation slowing in the near future.

02 Powell: Current Rates Allow for Patience, and "Next Move Is a Hike" Is Not Anyone’s Baseline Assumption

With today’s rate cut, the Fed has cut policy rates by a total of 75 basis points over the past three meetings. Powell said this will help inflation gradually return to 2% as the impact of tariffs fades.

He said that since September, adjustments to the policy stance have brought the policy rate within the range of various "neutral rate" estimates. The median forecast of FOMC members shows the appropriate level for the federal funds rate at the end of 2026 is 3.4%, and 3.1% at the end of 2027, unchanged from September.

Powell said that currently, inflation risks are tilted to the upside, while employment risks are tilted to the downside, making this a challenging situation.

A reasonable baseline judgment is that the impact of tariffs on inflation will be relatively short-lived, essentially a one-time upward shift in the price level. Our responsibility is to ensure that this one-time price increase does not turn into a persistent inflation problem. However, at the same time, downside risks to employment have increased in recent months, and the overall risk balance has changed. Our policy framework requires balancing the two sides of our dual mandate. Therefore, we believe it is appropriate to lower the policy rate by 25 basis points at this meeting.

As progress on inflation slowing has stalled, Fed officials had already hinted before this week’s decision that further rate cuts may require evidence of labor market weakness. Powell said at the press conference:

"Where we are now allows us to wait patiently and observe how the economy evolves."

In the Q&A session, when asked whether "the current policy rate is closer to neutral, and whether the next move must be down, or if policy risks have truly become two-sided," Powell responded that no one currently assumes a rate hike as the baseline, and he has not heard such views. There are different views within the committee: some members think the current stance is appropriate and advocate holding steady and observing further; others think another rate cut may be needed this year or next, possibly more than once.

When committee members write down their judgments on the policy path and appropriate rate level, expectations are mainly concentrated in a few scenarios: either staying at the current level, making a small cut, or a slightly larger cut. Powell emphasized that the mainstream expectations currently do not include a rate hike scenario.

Powell said that as an independent decision, the Fed also decided to start purchasing short-term US Treasuries, with the sole purpose of maintaining ample reserve supply over a longer period, thereby ensuring the Fed can effectively control the policy rate. He emphasized that these issues are separate from the monetary policy stance itself and do not represent a change in policy direction.

He said the scale of short-term Treasury purchases may remain high in the coming months. The Fed is not "worried" about money market tensions in the strict sense, but the situation has arrived a bit sooner than expected.

Powell also said, according to a statement from the New York Fed, the initial asset purchase scale will reach $40 billion in the first month and may remain high in the following months to ease anticipated short-term money market pressures. After that, the purchase scale is expected to decline, with the specific pace depending on market conditions.

On the labor market, Powell said that although official employment data for October and November have not yet been released, existing evidence shows that both layoffs and hiring activity remain at low levels. At the same time, households’ views on job opportunities and businesses’ perceptions of hiring difficulty are both declining. The unemployment rate continues to rise slightly, reaching 4.4%, and employment growth has slowed significantly compared to earlier this year. The Fed also no longer uses the phrase "the unemployment rate remains low" in its statement.

Powell said in the subsequent Q&A that after adjusting for overestimation in employment data, employment growth may have turned slightly negative since April.