December rate cut baked in, but Fed to signal cautious about rate-cut path ahead

Investing.com — The November inflation released this week helped cool fears that disinflation is stalling, giving the Federal Reserve room to cut interest rates next week, but the Fed’s confidence in the rate-cut path beyond December will turn from confident to cautious following signs of a stronger economy, analysts from Morgan Stanley (NYSE:MS) said in a Friday note.

“A downshift in shelter inflation in the November CPI report should reduce concerns that progress on inflation is stalling out,” the Morgan Stanley economists said. “A 25bp rate cut in December is baked in the cake,” they added ahead of the Fed’s Dec. 17-18 meeting.

The November CPI report showed a slowdown in rents and owners equivalent rent within the shelter component. While it is too early to say that this is a new trend shelter inflation, the analysts said that it provides evidence that “slowing rental inflation is gradually being incorporated into official measures of inflation.”

Beyond December, the Fed is likely to signal that rate cuts will continue, though there is uncertainty about how much and when.  

The Fed is likely to revise higher its growth and inflation forecasts higher following recent data pointing to signs economic strength, potentially forcing the central bank to rein in its rate cut forecasts.

“[T]here is a reasonable chance the committee revises higher its estimate for potential growth and the neutral rate,” the analysts said.

The Fed previously projected that rates would fall to 3.4% next year and  before eventually declining to 2.9% in 2026. 

“We still think the dot plot will show four rate cuts in 2025, but only one in 2026, for a terminal of 3.1%,” the analysts said. 

At the press conference that will follow the rate decision, Fed Chair Powell is likely to say that “the Fed will proceed with more caution on rate cuts going forward,” they added.