Why is the dot plot important ? will the Fed cut interest rates again

For the third consecutive meeting, the Federal Reserve (Fed) is anticipated to reduce interest rates on Wednesday. Every time the Federal Reserve determines rates, it is a critical event that directly impacts families and enterprises in the United States. Additionally, the Fed’s final meeting of the year will be significant in that it will offer a forecast of its actions in 2025.

The interest rate is the cost of borrowing money, and it is determined by the federal funds rate, which is established by the Federal Reserve. This includes personal loans, business loans, student loans, credit cards, and mortgages.

The Federal Reserve is not subject to the sanction of the United States federal government, as it determines the level of interest rates independently. Setting interest rates is one of the Fed’s most potent instruments, as it has a direct impact on the economy. High interest rates can increase the cost of borrowing for households and businesses, while lower rates can make it simpler and more cost-effective to secure a loan.

What is the significance of a rate reduction and what does it entail?

The Federal Reserve decreases the cost of financing when interest rates are reduced. This would be the third consecutive occasion that the US central bank has chosen to reduce rates this year, following the reductions in September and November.

In late summer, the Federal Reserve announced the conclusion of the rate-hiking cycle and the commencement of a new phase in which interest rates could be consistently reduced.

Evolution of interest rates in the United States over the past five years. Source: FXStreet.

However, what is the significance of this?

Lower rates will enable consumers and businesses to obtain loans at a reduced cost, as the Federal Reserve’s rate level significantly impacts the interest rate on any loan.

Therefore, this is advantageous for your financial situation.

Subsequently, envision the expansive. A reduction in rates can motivate thousands of individuals to obtain a loan in order to purchase substantial items at a reduced interest rate, thereby allowing them to allocate the funds elsewhere. Businesses are similarly able to acquire funds at a reduced cost in order to finance expansion. This is the reason why economies tend to expand when interest rates are reduced.

Is it possible for the Federal Reserve to reduce interest rates once more on Wednesday?

Indeed, it will. Another interest-rate reduction is nearly inevitable, according to economists and analysts who closely monitor the Federal Reserve.

According to data from the CME FedWatch Tool, investors have assigned a 97% likelihood that the Federal Reserve will reduce rates on Wednesday as of December 16. Only 3% of individuals anticipate that the US central bank will maintain interest rates at their current levels.

Market valuation of the Federal Reserve’s target rate probabilities for November. Source: CME Group FedWatch Tool. Several members of the Federal Open Market Committee (FOMC), which is responsible for determining interest rates, have indicated that they believe that another rate reduction is prudent. Nevertheless, the picture becomes increasingly hazy as we approach 2025, as the comments of an increasing number of Fed officials demonstrate a growing skepticism regarding the continuation of rate decreases (we will address this issue at a later time). Certainly, the Federal Reserve could choose to maintain current interest rates on Wednesday; however, this would be a significant surprise, and US central bankers typically refrain from shocking the market with such unforeseen decisions.

For what reason does the Federal Reserve reduce interest rates?

The Fed, the central bank of the United States, is responsible for two primary objectives: the promotion of stable prices and maximal employment.

The Federal Reserve was compelled to respond promptly in response to the inflation rout that occurred in the United States since 2022, as it was concerned that one of its mandates, price stability, was at risk. The central bank immediately increased interest rates in order to cool the economy and prevent further price increases, as prices were increasing rapidly.

The Consumer Price Index (CPI) indicates that prices reached a maximum of 9.1% in June 2022. Since that time, the inflation rate has steadily decreased, reaching 2.4% in September 2024, which is exceedingly near to the Federal Reserve’s 2% inflation target. Nevertheless, inflation has experienced a modest increase since that time, reaching 2.7% in November.

Development of annual inflation in the United States since 2020, as determined by the Consumer Price Index (CPI). Source: FXStreet.

The Fed’s concerns regarding inflation are gradually diminishing as price increases in the United States become more tightly managed. By itself, this justification would suffice to lower interest rates.

Nevertheless, there have been recent apprehensions regarding the Federal Reserve’s additional mandate: the promotion of full employment.

Employers have been consistently recruiting new employees to satisfy the robust demand for products and services in the United States since the pandemic’s conclusion. Accordingly, the labor market has been exceptionally active. In January 2023, the unemployment rate in the United States decreased to 3.4%, the lowest level in over five decades. This rate is calculated as the number of unemployed individuals divided by the total labor force.

However, the current state of the labor market is marginally different. The United States economy continues to generate employment opportunities on a monthly basis; however, the rate of growth has declined. The unemployment rate is currently at 4.2%, which is still low by historical standards. However, it has increased substantially in the past few months. The data indicates that the US labor market is experiencing a decline in momentum.

What is the anticipated extent of the Federal Reserve’s rate reduction?

By 25 basis points (bps), or a quarter-percentage-point, to a range of 4.25%-4.50%. The alternative, albeit highly improbable, is to maintain the current rates.

James Knightley, Chief International Economist at ING, recently stated that the Federal Reserve is anticipated to further reduce rates by 25bp on December 18 as it continues to transition from restrictive territory to a more neutral position.

It is generally anticipated that the Federal Reserve will adjust rates by a quarter percentage point on Wednesday, as is customary during normal cycles. However, the central bank may implement more substantial movements if it determines that it is necessary to act more promptly, as it did in September when it reduced rates by 50 basis points.

In an effort to stem inflation, the Federal Reserve has raised rates very aggressively on numerous occasions over the past few years.

Will the Federal Reserve maintain its rate-cutting efforts?

This is a critical inquiry for the meeting this week, and the response is expected to have a greater impact on the markets than the decision itself. Fed officials have stated on numerous occasions that the central bank is “data-dependent,” which implies that any future actions will be contingent upon the data collected regarding the status of the US economy.

The Federal Reserve typically monitors data concerning both inflation and the labor market. There is a growing body of evidence that inflation continues, albeit not at the same rate as in previous years, but still above the Federal Reserve’s desired level. This could imply that the Federal Reserve may indicate that it will exercise greater caution when it comes to reducing interest rates in the upcoming year.

However, the situation becomes more complex when considering the future, despite the fact that Wednesday’s interest-rate reduction appears to be a done deal.

The uncertainty is further compounded by the policies of President-elect Donald Trump, which include tariffs, personal and corporate tax cuts, and immigration controls. The majority of analysts regard these measures as inflationary, and their implementation would likely necessitate the Federal Reserve to reconsider its decision to reduce interest rates further.

The Federal Reserve’s interpretation of these subtleties will be transparent to all on Wednesday. Every three months, the US central bank releases a Summary of Economic Projections (SEP), which is commonly referred to as the “dot plot.” December is included in this publication.

This document contains a chart that illustrates the projections of numerous Federal Reserve members, each of whom is represented by a dot–hence the term “dot plot.” A convenient table summarizing the range of forecasts and, most importantly, the median is also included by the central bank. The table provides a distinct indication of the direction in which Fed officials anticipate interest rates to go.

The Federal Reserve’s most recent summary of economic projections, for the month of September. Federal Reserve.

Approximately 3.4% was the average rate that Fed officials anticipated at the conclusion of 2025, according to the most recent dot plot. The modification of this figure will be crucial in determining the extent to which policymakers’ sentiment has evolved in the wake of Trump’s victory and the recent inflation increase.

The majority of analysts anticipate that the bank’s projection will increase from the current 3.4%, which would result in fewer interest-rate cutbacks than had been previously predicted for the upcoming year.

“We expect the Fed meeting to include signals from policymakers that the pace of rate cuts will be slower going in the year ahead,” economists at Wells Fargo indicated.