The Fed will cut rates by a quarter point this week. But with core PCE inflation settling around a percentage point above target, the new economic projections should be used to strongly hint that the central bank is ready to follow a shallower path. After this week’s rate cut, the Federal funds rate may already be at neutral. That is why bonds continue to sell off.
If the Fed signalled it would pause in 2025, this would arguably be more bullish for the stock market in the medium-term. The alternative – looser monetary and fiscal policy – may juice the stock market and add to the ebullient mood in cryptocurrencies (e.g., memecoins like fartcoin) and AI in the near-term. But this would also push long-dated bond yields even higher. If the Fed is then forced to backtrack, and hike rates in 2025, to pin the long end down, the eventual unwind in some of these more speculative assets will be even more aggressive.
The Fed risks adding fuel to the fire of the current AI boom, if it eases too much in 2025. In such a scenario, US energy demand could outstrip supply sooner than expected, with utility providers unable to expand their capacity fast enough. The rapid build out of data centres is already pushing up electricity bills for consumers and driving emissions sharply higher. By stoking demand, the economy may come up against supply-side constraints sooner, pushing up inflation.
