The Fed's Widening Divisions on "Hawkish Rate Cuts" and Balance Sheet Expansion

1. Interest Rate Decision: Rate Cut as Scheduled but Internal Disagreements Highlighted

2. Benchmark Rate Adjustment

● In the early hours of December 11th, Eastern Time, the Federal Open Market Committee (FOMC) announced a reduction of the federal funds rate target range from 3.75%-4.00% to 3.50%-3.75%.

● This is the third rate cut this year, following September and October, with each cut of 25 basis points. So far, the total rate cuts in 2024 amount to 75 basis points.

● Since the current easing cycle began in September 2023, the Fed has cut rates by a total of 175 basis points.

2. Rare Disagreement Among Decision Makers

● This rate decision saw the first three-vote opposition since 2019.

● Board member Milan (appointed by Trump) advocated for a 50 basis point cut; two regional Fed presidents and four non-voting members supported holding rates steady.

● In total, seven officials opposed the decision, reportedly the largest disagreement in 37 years.

3. Key Changes in Policy Statement

● Rate Guidance Adjustment: The statement no longer broadly states “will assess the appropriate path going forward, considering the extent to which additional information may support a decision,” but explicitly says “when considering the extent and timing of future adjustments to the federal funds rate target range, the Committee will carefully evaluate the latest data, evolving outlook, and balance of risks.” This wording is interpreted as setting a higher threshold for rate cuts.

● Employment Market Description: The phrase “unemployment rate remaining low” was removed and replaced with “slightly risen as of September,” while acknowledging “risks to employment have increased in recent months.”

● Inflation Stance: Maintains the view that “inflation remains slightly above target,” with no substantial softening.

Second, Economic Forecasts and Dot Plot Signals: Slowing Pace

1. Rate Path Forecast (Dot Plot)

● The latest dot plot shows that the median projections for 2025-2027 are identical to those in September.

● Specifically:

○ End of 2025: Median rate forecast at 3.4%, implying only one 25 basis point cut next year.

○ End of 2026: Median forecast at 3.1%.

○ End of 2027: Median forecast at 2.9%.

● Of the 19 officials providing forecasts, 7 expect rates to stay within 3.5%-4.0% in 2025 (i.e., no cut), down by 1 from September.

2. Changes in Economic Outlook

● GDP Growth: Upward revision for 2024 and the following three years, reflecting recognition of economic resilience.

● Unemployment Rate: Slight downward revision of 0.1 percentage points for 2026, with other years unchanged, indicating a more resilient labor market than expected.

● Inflation Expectations: Slight downward revisions of 0.1 percentage points for PCE inflation and core PCE inflation in 2024 and 2025, showing slightly increased confidence in inflation easing.

3. Market Expectations Comparison

● CME FedWatch Tool before the meeting indicates:

○ Nearly 88% probability of a 25 basis point rate cut this time.

○ A 71% chance that rates will be cut again by at least 25 basis points by June 2025.

○ No more than 50% probability of rate cuts at the January, March, and April 2025 meetings.

● This decision aligns with an “hawkish rate cut”: implementing cuts but hinting at possible pauses afterward.

Third, Reserve Management Plan: Purchasing Short-Term Bonds to Maintain Liquidity

1. Operational Initiation and Purpose

● The Fed added a paragraph in the statement announcing that “reserve balances have fallen to ample levels, and the Federal Reserve will begin purchasing short-term government securities as needed to maintain an adequate supply of reserves.”

● This operation is defined as Reserve Management Purchases (RMP), aimed at rebuilding liquidity buffers in the money market to address potential year-end market pressures.

● Powell emphasized that this operation is separate from monetary policy stance and “does not signal a change in policy,” with the sole purpose of ensuring effective control of the policy rate.

2. Specific Implementation Arrangements

● Start Date: Beginning this Friday, December 13.

● Initial Scale: The New York Fed plans to purchase $40 billion in short-term government securities over the next 30 days.

● Subsequent Arrangements: Purchase levels may remain high over the coming months to ease seasonal pressures in the repo market; then gradually decrease based on market conditions.

● Background Considerations: Banks typically reduce repo market activities at year-end to meet regulatory and tax settlement needs, which can lead to liquidity stress.

Fourth, Chair Powell’s Press Conference Highlights

1. Policy Tone

● Patience: “Our current stance allows us to wait patiently and observe how the economy evolves.”

● Denial of Rate Hike Bias: Clearly states “I do not consider ‘the next move will be a rate hike’ as anyone’s base case,” emphasizing he has not heard such views.

● Risk Balance: “Inflation risks are tilted to the upside, while employment risks are tilted to the downside—this is a challenging situation.”

2. Internal Disagreements

● Three main views within the Committee:

○ Some members believe the current stance is appropriate and favor holding steady and observing further.

○ Some believe rate cuts may be needed again in 2024 or 2025, possibly more than once.

○ The expectation mainly centers on “maintaining the current stance, small cuts, or somewhat larger cuts.”

3. Inflation and Employment Interpretation

● Tariffs’ Impact: Views tariffs’ effect on inflation as “relatively short-lived,” essentially a one-time upward shift in price levels; the Fed’s role is to prevent it from evolving into persistent inflation.

● Employment Market: Although official employment data for October and November have not yet been released, existing evidence shows layoffs and hiring remain at low levels; households and businesses’ outlook on employment continues to cool.

4. Asset Purchase Clarification

● Reaffirms that short-term government securities purchases are an independent decision, not QE, and do not change the stance of monetary policy.

● Notes that the liquidity stress in the money market is “a bit faster than expected,” but not strictly a “worry.”

Fifth, Market Analysis and Forward Outlook

1. Policy Path Assessment

● The meeting sends a clear signal: after three consecutive rate cuts, the Fed is entering a pause phase.

● The dot plot shows only one rate cut expected in 2025, contrasting sharply with three in 2024, indicating a consensus on slowing the pace.

● The new wording of “considering the extent and timing” sets a higher threshold for future policy adjustments, possibly requiring clearer signs of labor market weakening.

2. Economic Environment Judgment

● The Fed faces balancing challenges between inflation and employment:

○ Inflation has stagnated, limiting further easing space.

○ Signs of cooling in the employment market suggest the need to guard against downside risks.

● Upward revisions in growth forecasts and downward revisions in inflation reflect an increased likelihood of a “soft landing,” but uncertainties remain.

3. Initial Market Impact

● Following the decision, US Treasury yields on the short end reacted mildly, with the long end slightly declining, reflecting market digestion of expectations for slower rate cuts.

● The US Dollar Index remains relatively strong, and stock market volatility is limited, indicating broad market acceptance of the “hawkish rate cut” narrative.

● Reserve management operations are expected to alleviate year-end liquidity pressures and prevent a repeat of the 2019 repo market turmoil.

4. Future Focus

● Data Dependence: Subsequent policies will heavily rely on inflation (especially core PCE) and employment data.

● Internal Coordination: How to reconcile decision-making disagreements into a more unified forward guidance.

● External Risks: Impact of global economic growth, geopolitical developments, and financial conditions.

● Technical Operations: Adjustments in the scale and pace of reserve management purchases and their effect on market interest rates.

This Fed meeting completed the third rate cut as expected, but through dot plot forecasts, wording adjustments in the policy statement, and Powell’s remarks, it clearly signaled a slowdown in easing. The rare internal disagreements highlight the difficulty of balancing inflation resilience and employment cooling. Meanwhile, initiating short-term government security purchases to manage reserves indicates the Fed’s proactive measures to address structural pressures in the money market.

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