Another Fed rate cut to finish 2025? Not so fast

The odds that the Federal Reserve will cut benchmark interest rates again in December are still high — but not as high as they were before last week’s cut.

As of Monday, according to the CME Group’s FedWatch tool, 70% of interest rate traders are anticipating another 25-basis-point pullback after the Fed’s final meeting of the year, which concludes Dec. 10. That’s down from 91% a week ago and 86% a month ago.

The reasons for the fading optimism are clear: Fed Chair Jerome Powell poured cold water on the notion that a cut next month is guaranteed, and opposing viewpoints are emerging as Jeffrey Schmid, the president of the Federal Reserve Bank of Kansas City, dissented from last week’s decision to cut rates.

Schmid released a statement that explained his rationale.

“By my assessment, the labor market is largely in balance, the economy shows continued momentum, and inflation remains too high,” the statement read in part. “I view the stance of policy as only modestly restrictive. In this context, I judged it appropriate to maintain the policy rate at this week’s meeting.”

Inflation fears keep policy in check

The federal funds rate is currently at a range of 3.75% to 4%, its lowest level in three years. It had gone as high as 5.25% to 5.5% in July 2023, which marked the last in a long series of hikes implemented by the Fed as it tried to combat 40-year-high inflation.

Since then, the Fed has left rates unchanged on several occasions. But it has also reduced them by a total of 150 bps, starting with a 50-bps cut in September 2024, followed by four more cuts of 25 bps each.

Mortgage rates have not moved in a straight line with these policy moves. In fact, in the wake of last year’s 50-bps cut, they rose from a low point of 6.25% to a peak of nearly 7.2% in January.

Fears of renewed inflation emerged at the start of the second Trump administration, which were tied to the president’s global tariff regime.

But while annualized inflation has increased marginally to 3% as of September, tariffs haven’t caused the prices of goods and services to skyrocket back toward their 2022 peak of 9%. And mortgage rates have gradually subsided to their current levels near 6.25%.

Still, the potential for higher inflation is influencing decision makers like Schmid.

“Talking to contacts in the Kansas City Fed’s district, I hear widespread concern over continued cost increases and inflation,” he said. “Rising healthcare costs and insurance premiums are top of mind. In the data, inflation is spreading across categories, both goods and services. Inflation has been running above the Fed’s 2 percent objective for more than four years.

“As I have said before, I take small comfort in most measures of inflation expectations having not moved up. I view inflation expectations not as an input into Fed’s decisions, but as the outcome of the policy decisions that the Fed makes.”

‘Hug a mortgage spread’

On a recent episode of the HousingWire Daily podcast, Lead Analyst Logan Mohtashami said that fears of rising mortgage rates colliding with Fed cuts — similar to what happened at this time last year — are unfounded due to the softening labor market.

“If it wasn’t for that, mortgage rates would be higher because the Fed will say we’re modestly restrictive (with policy),” Mohtashami said. “So, hug a mortgage spread and thank bond traders for getting ahead of the Fed. They do a lot of what we’ve always said — heavy lifting for the Federal Reserve early on.”

In a post published Tuesday, Desmond Lachman, a senior fellow at the American Enterprise Institute, backed the recent policy decisions by Powell and the Fed.

Along with the data blackout tied to the federal government shutdown, Lachman wrote that the rise of artificial intelligence — and its potential to reduce the number of jobs — is complicating the central bank’s ability to read the tea leaves for the future of the U.S. labor market.

“At a time of an AI revolution whose future is difficult to divine, it is all the more challenging to successfully steer the US economy,” Lachman said. “This makes me inclined to think that Powell is right not to make big changes in monetary policy at this juncture and to be guided by the incoming data when it eventually resumes to make his interest rate decisions.”