Recent economic data releases have led the market to develop new expectations regarding the Federal Reserve's rate cut trajectory. Although it was previously widely anticipated that the Federal Reserve would continue to cut rates, the latest analysis from Deutsche Bank suggests that conditions for pausing rate cuts this year are quite stringent, with a potential for another 25 basis point cut in December. However, by 2025, the possibility of pausing rate cuts is significantly increasing due to a combination of seasonal inflation effects and political factors.
Strategists at Deutsche Bank noted a noticeable shift in market sentiment following the Federal Reserve's substantial 50 basis point rate cut in September, with many investors starting to speculate about when the Fed might stop cutting rates. However, according to Deutsche Bank's policy rule analysis, under the current economic environment, the Federal Reserve still has the potential to cut rates again in December, with policy rates expected to remain below 4.5%.
The analysis indicates that one of the core conditions for the Federal Reserve to pause rate cuts is for inflation to exhibit "stickiness," meaning that the core personal consumption expenditures (PCE) inflation rate consistently remains around 0.3%, indicating sustained price pressures. Additionally, downside risks in the labor market also need to be alleviated, including unemployment rates stabilizing at or below 4.1%, steady wage growth, and improvements in other labor market indicators. Deutsche Bank states that if these conditions are met in December, the Federal Reserve might carefully consider pausing rate cuts. However, data changes under the influence of hurricanes and the November Consumer Price Index (CPI) could add a layer of policy complexity.
Strategists further analyzed that the likelihood of pausing rate cuts in 2025 is increasing, particularly amidst rising policy uncertainty following the U.S. elections. Deutsche Bank points out that seasonal inflation effects might drive inflation data higher at the start of 2025, prompting the Federal Reserve to be more cautious in future rate cuts. In a scenario where the Republicans win comprehensively and tariff policies are unaffected, the Fed might face more hawkish pressure. Conversely, if Trump is re-elected and maintains tariffs, or if there is a coexistence of the Kamala Harris administration with a Republican-controlled Senate, the Fed's policy stance may become more complex driven by inflation and economic data.
Moreover, Deutsche Bank emphasizes that the Federal Reserve's policy path heavily relies on estimates of the neutral rate, with the current policy rate only about 125 basis points above the bank's forecast of the neutral rate. Therefore, even though the Federal Reserve might cut rates again in December, subsequent policy directions would still need to adjust according to the performance of inflation and employment data.
Deutsche Bank forecasts that even with strong expectations for a rate cut in December, the probability of pausing rate cuts in early 2025 is rising, and the market should closely monitor future data for guidance on the Federal Reserve's policy direction.
