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Investment Strategy
by Larry Adam
Chief Investment Officer, Private Client Group
How the Fed’s dot plot may shift at the December FOMC meeting
December 13, 2024
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Key Takeaways
- The Fed’s growth and inflation projections should be revised higher
- The Fed’s new dot plot should reflect fewer rate cuts in 2025
- The scope for meaningful declines in bond yields is limited
Should I Stay or Should I Go Now? That is the question the Fed is contemplating right now as it heads into the final meeting of the year next week (December 17-18). While a 25 bp rate cut is likely as policymakers do not like to surprise the market (the market is pricing in a 95% probability of a rate cut), the ongoing strength in the economy and stalled progress on the inflation front is starting to ring some alarm bells for policymakers. And that’s before any consideration is given to the potential policy shifts (i.e., tax cuts, tariffs, immigration crackdowns) that are looming on the horizon. While there are still too many unknown unknowns, policymakers still need to make judgments about how best to steer the economy with the information they have at hand. Below we preview how the Fed’s economic projections and dot plot may shift at next week’s FOMC meeting and what impact this will have on the fixed income and equity markets.
- Updated Economic Projections | The US economy is powering ahead, with considerable momentum as we head into 2025. Case in point: the Atlanta Fed’s Q4 GDPNow has climbed to 3.3% and shows no signs of slowing down, thanks to resilient consumer spending and ongoing fiscal tailwinds. This momentum is likely to prompt the Fed to raise its near-term growth forecasts from 2.0% to ~2.3%. Despite hurricane-related distortions and conflicting messages between the two employment surveys making the read on the labor market outlook more challenging, we don't expect major changes in the Fed’s labor market projections. The peak unemployment rate is still likely to remain at 4.4% in 2025. The biggest wildcard in the updated projections will be the Fed’s inflation estimates. Recent data suggests that the disinflation process has stalled, which is unsettling for the more hawkish members of the committee. Consequently, we expect the Fed to raise its 2025 inflation estimate from 2.2% to a few tenths higher.
- New Dot Plot | Most Fed officials believe that monetary policy remains restrictive. However, the economy’s resilience is questioning this view. With big policy shifts (i.e., tariffs, tax cuts, immigration) on the horizon, the dots will be scrutinized to gauge how the Fed is leaning given the uncertainties. While Chair Powell has stated that the Fed will not speculate on any policy proposals, Fed members are likely thinking through the longer-term impacts (at least in their base line forecast) as they pencil in their new dot plot projections. This may lead to an even wider dispersion than normal. But with growth remaining solid and 75 bps (soon to be 100 bps if the Fed cuts in December) of ‘insurance’ rate cuts already implemented, the Fed will likely remove a few rate cuts across its forecast periods. This should shift the median dot higher—with the 2025 dot likely to move up to 3.9% from 3.4%. Of particular interest will be the Fed’s estimate of its long-term neutral rate (the level that neither stimulates nor restricts growth), which is expected to be revised higher from its current 2.9% level. The big question is to what extent, especially given that the Fed’s long-run estimate is below the current market estimate of ~3.75%.
- Powell’s Press Conference | Despite the resilient economic backdrop, we expect the Fed to deliver a 25 bp rate cut next week. However, given the upward revisions to the Fed’s economic and interest rate projections, Chair Powell is likely to strike a more balanced tone when he takes the podium—explaining the rationale and prepping the market for the upcoming pause. There will inevitably be many questions about how President-elect Trump’s policies are impacting its outlook, which we expect him to deflect as much as possible.
- Asset Class Views | Below outlines how a shallower Fed easing cycle (fewer cuts) may impact the equity and fixed income markets:
- Equities | With the Fed still in easing mode, equities should continue to be well supported. While the Fed may pull off a ‘hawkish’ cut (i.e., a cut with less guidance for future cuts), our focus is less on the number of cuts and more on the overall economic trajectory. And with the economy still showing momentum, earnings should maintain their climb in 2025—reinforcing our positive longer-term outlook. However, with the market priced for perfection and valuations at historically stretched levels (S&P 500 LTM PE: 25.5x), a shallower easing cycle in 2025 could lead to a near-term pullback and increased equity volatility.
- Fixed Income | Treasury yields have defied historical patterns by rising instead of falling after the Fed’s initial rate cut. This sharp increase came on the heels of better than expected economic data and sticky inflation, prompting the market to reassess the Fed’s expected rate path. With a Fed pause likely on the horizon, yields are likely to stay elevated to reflect this new reality. We anticipate the yield curve will steepen further, with the front end anchored by Fed policy rates while longer maturities drift modestly higher due to stalled progress on disinflation and concerns about worsening fiscal dynamics. In this environment, the potential for a significant decline in yields is limited, but bonds still offer reasonable income opportunities in what is likely to be a range-bound market.
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