The central bank's expectation of just two rate cuts in 2025 rattled Wall Street, sending stock prices plummeting in the worst day for the market in four months. The Dow Jones Industrial Average closed down more than 1,100 points, roughly 2.5%. The Nasdaq composite was hit worse: It sank about 3.5% Wednesday.
At a news conference, Chair Jerome Powell underscored that policymakers are slowing their rate reductions as their benchmark rate nears a level that policymakers refer to as “neutral” — the level that is thought to neither spur nor hinder the economy.
Wednesday's projections suggest that the policymakers think they may be close to that level. Their benchmark rate stands at 4.3% after the latest rate cut, which followed a steep half-point reduction in September and a quarter-point cut last month.
“I think that a slower pace of (rate) cuts really reflects both the higher inflation readings we’ve had this year and the expectations that inflation will be higher" in 2025, Powell said. "We’re closer to the neutral rate, which is another reason to be cautious about further moves.”
Blerina Uruci, chief economist at T. Rowe Price, said the tone of Powell's news conference was surprisingly “hawkish,” meaning that it seemed to favor maintaining relatively high rates.
Uruci noted that Powell said the Fed's decision Wednesday to reduce its benchmark rate by a quarter-point was a “closer call,” suggesting that there was opposition to the move. Indeed, one member of the central bank's interest rate committee — Beth Hammack, head of the Federal Reserve Bank of Cleveland — dissented in favor of keeping rates unchanged.
“The committee might be quite divided at this point," Uruci said. "And we have a growing hawkish contingent.”
At his news conference, Powell acknowledged that at least some Fed officials have begun to assess the potential effects of President-elect Donald Trump's policies on the economy and inflation. The Fed chair noted that some policymakers think that since the election, the future path of inflation has become harder to gauge. Trump's threats to impose tariffs on all imports and to engage in mass deportations of migrants could worsen inflation next year.
“It’s kind of common-sense thinking that when the path is uncertain, you go a little bit slower,” Powell said. “It’s not unlike driving on a foggy night or walking into a dark room with furniture.”
This year's Fed rate reductions have marked a reversal after more than two years of high rates, which largely helped tame inflation but also made borrowing painfully expensive for American consumers.
But now, the Fed is facing a variety of challenges as it seeks to complete a “soft landing” for the economy, whereby high rates manage to curb inflation without causing a recession. Chief among them is that inflation remains sticky: According to the Fed’s preferred gauge, annual “core” inflation, which excludes the most volatile categories, was 2.8% in October. That is still persistently above the central bank’s 2% target.
At the same time, the economy is growing briskly, which suggests that higher rates haven’t much restrained the economy. As a result, some economists — and some Fed officials — have argued that borrowing rates shouldn’t be lowered much more for fear of overheating the economy and re-igniting inflation.
On the other hand, the pace of hiring has cooled significantly since 2024 began, a potential worry because one of the Fed’s mandates is to achieve maximum employment.
“We don’t think we need further cooling in the labor market to get inflation below 2%,” Powell said at his news conference.
The unemployment rate, while still low at 4.2%, has risen nearly a full percentage point in the past two years. Concern over rising unemployment contributed to the Fed’s decision in September to cut its key rate by a larger-than-usual half point.
Asked why the central bank envisions any rate cuts in 2025 given still-elevated inflation, Powell noted that the Fed's latest projections “have core inflation coming down to 2.5% next year."
“That would be significant progress,” he said. “We’d be seeing meaningful progress to get inflation down to that level.”
The Fed chair added: “We and most other forecasters still feel that we are on track to get down to 2%. It might take a year or two from here.”
Trump has proposed a range of tax cuts — on Social Security benefits, tipped income and overtime income — as well as a scaling-back of regulations. Collectively, these moves could stimulate growth. At the same time, Trump has threatened to impose a variety of tariffs and to seek mass deportations of migrants, which could accelerate inflation.
Powell acknowledged that Fed officials are seeking "to understand ways tariffs can affect inflation and the economy and how to think about that.”
The Fed's uncertainty about the economy's future path was underscored by the quarterly economic projections the Fed issued Wednesday. The policymakers now expect overall inflation, as measured by their preferred gauge, to rise slightly from 2.3% now to 2.5% by the end of 2025. That is far below its peak of 7.2% in June 2022.
Even so, the prospect of slightly higher inflation makes it harder for the Fed to reduce borrowing costs because high interest rates are its principal weapon against inflation.
“From here, it’s a new phase," Powell said, "and we’re going to be cautious about new cuts.”
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AP Business Writer Alex Veiga contributed to this report from Los Angeles.
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