Markets scale back US Fed rate cut bets for 2025 amid inflation uncertainty

Market expectations of multiple rate cuts from the US Federal Reserve this year have weakened after US consumer prices rose more than expected in January, increasing the likelihood that the central bank will keep interest rates higher for longer.

The headline consumer price index (CPI) rose by 0.5% in January, while the core index increased by 0.4%, both exceeding expectations of a 0.3% rise. This pushed the annual headline CPI increase to 3.0%, above the anticipated 2.9%, while core prices rose at an annual pace of 3.3%, surpassing the expected 3.1% rise.

Although inflation has declined sharply from the 40-year peak reached in mid-2022, the Fed’s 2% target remains elusive. In 2024, the US Federal Reserve implemented three consecutive interest rate cuts, totalling a reduction of 1 percentage point, bringing the federal funds rate to a target range of 4.25% to 4.50% by year-end.

However, the Federal Open Market Committee kept rates unchanged last month to assess how President Donald Trump’s policies will affect the economy. Policymakers are closely watching White House trade policy, with President Donald Trump pushing aggressive tariffs that also could boost prices and complicate the Fed’s desire to get to its goal.

The higher inflation reading in January has reinforced the Fed’s message that it was in no rush to resume cutting rates. On Wednesday, Federal Reserve Chair Jerome Powell appeared before the House Committee on Financial Services and noted that January’s hotter-than-expected CPI data serves as a reminder that the Fed has made “great progress” toward bringing inflation closer to its 2% target but is “not quite there yet.”

Before the Senate Banking Committee on Tuesday, Powell stated that central bank policymakers “do not need to be in a hurry” to cut interest rates further. “We know that reducing policy restraint too fast or too much could hinder progress on inflation. At the same time, reducing policy restraint too slowly or too little could unduly weaken economic activity and employment,” he said.

With the January CPI numbers, markets have lowered their rate cut expectations to just one -25 basis points in 2025 from earlier 3-25 basis points reduction.

While the Fed monitors CPI and other price measures, its preferred inflation gauge is the personal consumption expenditures (PCE) price index, which the Bureau of Economic Analysis will release later in February.

Meanwhile, January’s inflation reading is the last inflation reading before any direct impact from Trump’s tariff measures, which went into effect this month. On Thursday, Trump directed his economic team to formulate plans for reciprocal tariffs on every country that imposes taxes on U.S. imports. Earlier this week, Trump had also announced a hike in tariffs on steel and aluminum imports to 25% “without exceptions or exemptions.”

JM Financial sees 50 bps rate cut

The hotter-than-expected CPI print dashes hopes of policy easing in the near term. This unexpected pickup in inflation calls for a re-evaluation of the Fed’s inflation projections, as the impact of higher tariffs is likely to reflect in upcoming CPI prints, said domestic brokerage firm JM Financial.

The housing category, which has the highest weight in the CPI basket, fueled headline inflation but is expected to ease gradually. Strength in wage growth and an improved unemployment rate indicate a healthy labor market, which the brokerage expects will likely propel consumption demand.

The brokerage believes that the actual tariffs are likely to be lower than what was threatened in the run-up to the presidential election and will most likely be used as a negotiation tactic for a favorable deal for the U.S. Hence, this scenario leaves room for policy easing, with the brokerage factoring in a 50 basis point rate cut by the end of 2025, compared to market expectations of a 25 bps cut.

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