As the Federal Reserve gradually shifts its interest rate journey from a "fast lane" to a "slow lane," global investors find themselves pondering whether they are adequately prepared to navigate the potential bumps along the wayThe anticipation builds as the Fed gears up to announce its highly anticipated December interest rate decision at 3 AM Beijing time this Thursday, followed by a customary press conference featuring Chair Jerome Powell half an hour later at 3:30 AM.

The prevailing sentiment among experts is overwhelmingly in favor of a 25 basis point rate cut at this week’s meeting, with little room for surprisesShould this occur, it would mark the third consecutive meeting in which the Fed has enacted a rate reduction, culminating in a total decrease of 100 basis points for the year.

Market pricing for interest rate swaps currently reflects a staggering 95% probability of a Fed reduction tonight

Such a high probability is uncommon and typically suggests that unexpected outcomes are rareSupport for this view is further bolstered by a media survey indicating that out of 103 economists polled, a staggering 93 expect the Fed to take action to lower rates this week.

Even as it seems almost a foregone conclusion that the Fed will announce a rate cut tonight, this meeting is likely to bear the mark of significanceNot only will this be the final rate cut of 2024, but notable markers—such as those cited by prominent journalist Nick Timiraos, often referred to as the "new Fed whisperer"—suggest that many Fed officials have hinted this rate cut could signify the conclusion of the first phase in a two-stage rate reduction cycle.

Reflecting on the characteristics of the Fed's current rate-cutting phase, it is evident that it has been characterized by frequent reductions with relatively low thresholds

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The Fed began cutting rates rather belatedly in September, and no sooner had they commenced than they made a striking move by slashing rates by 50 basis pointsJust last month, another cut of 25 basis points followedFurthermore, the threshold for these cuts has been low, given that borrowing costs had been maintained at high levels prior to this easing cycle.

At this juncture, however, Fed officials are facing a potential pivot pointThere are signs that the stability of the U.Slabor market has improved since September, and inflation is showing slight upticksThis scenario compels Powell to seek a more suitable level of monetary easing, as he navigates concerns from colleagues about continuing to cut rates, particularly in light of the softened support for successive reductions.

Against the backdrop of discussions surrounding trade, immigration, regulatory reform, and tax policies, there’s a growing sense that such factors could reshape the U.S

economic landscape, including growth, employment, inflation, and debt projections over the coming years.

Consequently, many in the industry believe that as we transition into next year, the Fed’s rate-cutting phase is likely to take on a more measured approach, with action slowing down and thresholds risingAchieving another seamless series of three consecutive cuts like we are witnessing at the end of this year may not be an easy feat...

One particular area of interest for investors tonight will be whether the Fed will hint at a pause in rate cuts for January.

A pertinent question for today's interest rate decision is whether the Fed might offer subtle signals regarding a pause in cuts come JanuaryIf deemed necessary, the Fed could likely weave this insight into its policy statement post-meetingPowell might also address this topic during the press conference, whether prompted directly by questions or expressing it preemptively.

According to the CME Group’s FedWatch tool, traders currently assign only a 16.3% probability that the Fed will cut rates further to a range of 4.00%-4.25% in January.

It’s clear that many Wall Street institutions believe the Fed could take advantage of this meeting to release signals that indicate a pause or deceleration in forthcoming cuts

Such views were echoed in a report from Yardeni Research last Sunday, which posited that Powell may use the post-meeting press conference to convey a message of pausing for further easing.

Goldman Sachs’ chief economist Jan Hatzius shares a similar outlook, predicting that the main takeaway from December’s meeting will signal an anticipation of a slower pace in future cutsHis recent report eliminated the expectation for a January cut and now anticipates three total cuts in March, June, and September of next year.

Danske Bank believes Powell will aim for neutrality in his remarks but is likely to keep the door open for a gradual slowdown in easing.

Recently, several Fed officials have begun indicating that they require solid evidence of either a reduction in inflation or worsening conditions in the labor market before committing to further cuts in borrowing costs.

Indeed, Cleveland Fed’s Loretta Mester remarked earlier this month that, “We have reached or are near the point where we should slow our pace of cuts.” She contrasted this with instances from the 1990s, when the Fed swiftly implemented a cumulative reduction of 0.75%, before adopting a wait-and-see stance.

Another key point of interest in the Fed's decision tonight will be how many times it might consider cutting rates next year.

In addition to whether the Fed will signal a pause in cuts for January, another focal point of tonight’s decision will be the quarterly issuance of the Fed's dot plot, which serves to reflect the rate outlook

This renowned chart might shine a light on two critical questions: how many cuts the Fed anticipates next year and what it sees as the current neutral interest rate.

The neutral interest rate is seen as the equilibrium level, one that neither stimulates nor constrains economic activity—a level on which policymakers often fixateHowever, estimating this level is no simple matter, as economists continue to offer a range of calculationsThe closer the Fed approaches this estimated level of neutral rate amid solid inflation and a stable labor market, the less justification there is for further cuts.

The exact positioning of what the Fed perceives as an ideal neutral rate will directly impact its judgment on how many times it ought to cut rates in the coming yearEarlier this month, Powell remarked that a robust economy indicates that the Fed need not rush into further cuts, though details surrounding each potential cut's timing remained scant

He underscored the uncertainty of identifying where the “neutral” rate lies, asserting, “We can only know through practice.”

During the September meeting, the median projections of the Fed’s dot plot indicated a total expected cut of 100 basis points for both this year and the following yearNevertheless, following a series of stubborn inflation readings and cautious commentary from Fed officials, doubts have arisen surrounding the feasibility of achieving such cuts by 2025.

Numerous major Wall Street firms have recently begun to foresee that the Fed may cut rates one less time than previously envisioned in September—this translates into a potential total cut of merely 75 basis pointsSome analysts have suggested that the Fed might ultimately cut rates by only 50 basis points, aligning closely with the current pricing reflected in the swaps market.

Former Cleveland Fed official Loretta Mester recently expressed that the Fed’s previous predictions of four rate cuts “must be reassessed,” projecting a shift to a “slower” pace by 2025. She noted, “Two to three cuts seem appropriate to me.”

Danske Bank predicts that by the end of 2025, the median value of the federal funds rate may rise by 25 basis points compared to September’s dot plot, reaching 3.625%. They further noted that, considering recent data, the possibility of a further upward adjustment of 50 basis points shouldn’t be dismissed

Estimates for long-term rates may also rise from an anticipated 2.9% in September to above 3%.

Goldman, on the other hand, anticipates that the median value of the dot plot will indicate three cuts in 2025 (to 3.625%) along with two cuts in 2026 (to 3.125%), remaining steady at 3.125% in 2027. All projections reflect a 25 basis point increase from the dot plot issued in SeptemberMoreover, Goldman expects that the estimates for long-term or neutral rates could rise by 0.125 basis points to 3%.

In summary, one fundamental takeaway from these predictions by investment banks is that if the Fed's dot plot forecasts a scale-back on the number of cuts next year to three, this would align with current expectationsA reduction to just two would signal an even more hawkish outcomeAdditionally, a noteworthy detail is that the Fed's estimates for long-term rates might witness a potential increase toward 3%.

As investors gear up for the Fed’s decision tonight, additional considerations surface.

In terms of finer details, Goldman suggests that the key issue within the Fed's policy statement lies in whether officials will emphasize a slower pace of rate cuts or make decisions predicated on incoming data from each meeting

They forecast a balance of messages conveying both perspectives, alongside potential hints woven into the statement.

Moreover, the Fed’s quarterly economic projections (SEP), which encompass the dot plot, will unveil the latest forecasts regarding the economy, inflation, unemployment, and interest ratesThis array of information is vital for gauging future monetary policy trajectories.

Wells Fargo's report anticipates that the Fed's latest projections will reflect that recent U.Seconomic performance has exceeded prior expectationsForecasts for real GDP growth in 2025 and 2026 could witness slight increases of 0.1 or 0.2 percentage points from September’s predictions, while unemployment forecasts might dip by 0.1 percentage pointsIn light of intensified pricing pressures, inflation forecasts for 2025 and 2026 might also rise by 0.1 or 0.2 percentage points.

ING has suggested that the Fed's predictions for economic growth and inflation heading into 2024 may see minor upward revisions, while unemployment projections slightly decline

However, significant shifts in the 2025 outlook are not anticipated.

Additionally, Goldman forecasts the Fed’s unemployment rate estimate for next year to remain consistent with this year’s level (both at 4.2%), while inflation predictions could rise to 2.4%, surpassing September’s 2.1%.

Notably, the minutes from the Fed’s November meeting had revealed that some decision-makers considered the idea of undertaking a “technical adjustment” to the offer rate for overnight reverse repurchase agreements, aligning it with the bottom of the federal funds target rangeObservers will be eager to ascertain whether the Fed will implement such changes in tonight’s announcement.

The overnight reverse repurchase agreement rate plays a crucial role within the short-term interest rate components established by the Fed, which also include the interest rate on excess reserves and the federal funds rate itself—the reverse repo rate typically reflects the lower limit of the federal funds rate corridor.

Lastly, an intriguing element of tonight’s Fed ruling centers on whether Powell will address the implications stemming from the 2.0 policy adjustments in the previous meeting.

As highlighted by Nick Timiraos from earlier reports, proposals surrounding trade, immigration, regulation, and taxation could significantly reshape economic growth prospects and employment figures, as well as inflation outlooks, prompting deeper considerations from Fed officials.

For instance, stricter immigration practices might elevate wages while dampening demand, and tariffs could raise prices but simultaneously compress profit margins or curtail corporate confidence

Any expansion in energy production could counterbalance price hikes in different sectors.

Powell has previously stated that the Fed should avoid speculations regarding the potential impacts of these policiesIn an earlier address this month, he listed various unknown factors about tariffs, including which products and countries may face tariffs, the scale of such tariffs, how companies might be alerted, and how other nations may respondHe emphasized, “We must wait and see.”

Yet, some former Fed officials believe it cannot be overlooked that these potential shifts in immigration and trade policies ought to factor into the Fed's outlook because they can be enacted without congressional approval.

Eric Rosengren, who served on the Boston Fed from 2007 to 2021, stated, “Making projections in mid-December is complicated by the anticipated changes set to take place starting January 20.”