The Federal Reserve is widely expected to cut interest rates on Wednesday, but there’s growing uncertainty about whether it’s the right move. According to CNBC’s December Fed Survey, 93% of respondents—consisting of economists, fund managers, and strategists—expect a quarter-point rate cut. However, only 63% believe the Fed should make this move.
This hesitancy comes amid forecasts of persistent inflation, stronger-than-expected growth, and a tighter labor market heading into President-elect Donald Trump’s administration. While markets are pricing in two additional rate cuts in 2025, the funds rate is still expected to remain at 3.8% by next year and gradually decline to 3.4% by 2026.
Trump’s Policies: A Double-Edged Sword for Growth
The uncertainty stems largely from Trump’s proposed fiscal policies, which respondents believe present both opportunities and risks. Some, like economists Troy Ludtka and Joseph LaVorgna from SMBC Nikko Securities Americas, see Trump’s election as a boost for economic sentiment. They wrote, “Initial indications are that the Trump election has stoked animal spirits amongst consumers, households, and small businesses.”
However, not everyone shares this optimism. Many survey participants worry about the mix of inflationary and disinflationary effects from Trump’s policies. Economist Robert Fry expressed the dilemma, saying, “President-elect Trump is offering us a mix of inflationary (tariffs, individual tax cuts) and disinflationary (deregulation, spending cuts) policies. Who knows what combination we’re going to end up with?”
Inflation Risks Take Center Stage
The survey reflects growing concerns about inflation. A majority—56%—believe Trump’s policies will be “somewhat inflationary,” while another 11% see them as “extremely inflationary.” Tariffs, in particular, remain a critical focus.
Trump’s proposed 10% tariffs on Chinese imports are widely expected to materialize, with 70% of respondents predicting they will go into effect. Meanwhile, the fate of the threatened 25% tariffs on Mexico and Canada is seen as hinging on trade negotiations.
Economist Joel Naroff summed up the risks, stating, “The economy remains surprisingly strong and the only risks on the horizon stem from potential tariffs and the possible deportation of essential, largely non-replaceable immigrant workers.”
Stocks: Limited Upside and Overvaluation Concerns
While the S&P 500 forecast has improved slightly, the outlook for equities remains muted. The index is expected to rise just 3% next year and 7% by 2026. A notable 69% of respondents view stocks as overpriced, particularly if the economy achieves a soft landing.
Subodh Kumar, president of Subodh Kumar & Co., pointed to stretched valuations: “At almost 25 times the price-earnings multiple on consensus-anticipated earnings for the S&P 500, valuation appears fulsome.” He noted that current markets seem to be assuming annual earnings growth far above sustainable levels.
Recession Risks Fade as Soft Landing Predicted
Despite the policy uncertainties, the probability of a recession has dropped to a two-year low of 29%, with nearly 70% of respondents forecasting a soft landing for the economy. GDP is expected to grow by 2.5% this year before cooling slightly to 2.1% in 2025 and 2026.
However, the tight labor market remains a wild card. John G. Lonski, president of The Lonski Group, cautioned that sustained economic growth above 2.5% could further tighten the labor market, driving inflation higher. “The longer the economy grows faster than 2.5% annualized quarter-to-quarter, the greater is the risk of an inflationary tightening of the U.S. labor market.”
The Fed’s Dilemma: Inflation vs. Financial Conditions
Richard Bernstein, CEO of Richard Bernstein Advisors, captured the challenge facing the Fed. “Financial conditions are remarkably easy, yet the Fed feels it must cut rates. … More inflation than is current consensus seems the ultimate path.”
The combination of easy financial conditions, robust economic growth, and inflationary risks creates a balancing act for the Federal Reserve. While a rate cut appears inevitable this week, the real test will be the Fed’s forward guidance on rates for 2025 and beyond.
Conclusion: Uncertainty Dominates the Outlook
As the Federal Reserve prepares to make its final decision of the year, markets remain on edge. Trump’s policies, inflation fears, and lingering questions about tariffs all contribute to a murky outlook. While recession fears have eased and the economy remains surprisingly strong, inflation risks could keep the Fed cautious, even as it begins to loosen policy.