Wednesday’s 25-basis-point rate cut by the U.S. Federal Reserve was not a unanimous decision. Beth Hammock, appointed in May as president of the Cleveland Fed, dissented, preferring no rate cut this time around. It was this year’s second thumb-down vote. Fed governor Michelle Bowman disagreed with the central bank’s 50-basis-point cut in September.
In a speech delivered earlier this month, Bowman — who voted in favour of yesterday’s move — told attendees of the Missouri Bankers Association Executive Management Conference, “I would prefer that we proceed cautiously and gradually in lowering the policy rate, as inflation remains elevated.”
Hammock was joined by three non-voting members of the Federal Open Market Committee (FOMC), who also disagreed with the latest rate cut.
The Fed’s range for its key interest rate is now 4.25% to 4.5%. The cut had largely been priced in by investors. What surprised some however was Fed chair Jerome Powell’s messaging on future rate cuts, the so-called dot-plot projection. Investors were told to expect two cuts in 2025, not four as had been forecast in September. Both are expected to be 25-basis-point reductions.
U.S. and Canadian markets tumbled as a result. The S&P 500 fell close to 3% and the S&P/TSX Composite Index dropped more than 2%. The U.S. benchmark was flat today, while the TSX dropped another 143 points.
“[It was] a little bit of an overreaction,” Michael Gregory, deputy chief economist at BMO Capital Markets said in an interview. “Now we have to wait and see what happens.”
The loonie rose in value today, but remained below 70 cents US. It’s at a low not seen since 2016.
“The Canadian dollar will continue to drift weaker,” Gregory said. “We do think that the Fed and the Bank of Canada are both likely to cut interest rates in March, so we’re in a bit of a holding period.”
Our dollar is down close to 8% this year, relative to the greenback. Like the Fed, the Bank of Canada has signalled its intention to slow down the pace of rate cuts in the new year.
While the U.S. dollar has strengthened since Donald Trump won the presidential election, his incoming administration’s tariff threats present significant risk on both sides of the border. It could help explain the Fed’s cautious approach, Gregory said.
“There’s much more uncertainty,” he said. “You have no clue what’s going to happen in the next three, six or nine months. Will there be tariffs? Will there be a huge run-up in the deficit? As a result, you’ve got to be a little bit more cautious.”
In a note to investors, TD Economics director & senior economist James Orlando wrote that this more careful approach is likely to continue in the new year. “With the Fed’s preferred inflation rate stuck at 2.8% year-on-year, and expectations that President Trump will follow through on his inflationary political strategy, it makes sense that the Fed will be much more cautious come the New Year.”
TD has not ruled out a January rate cut in the U.S., however. Neither has RBC Economics.
“Powell continued to push back against discussing the impact of potential tariffs, referencing high levels of uncertainties with regard to the shape and form the policies could take on,” wrote Claire Fan, an economist at RBC Economics, in her own note.
Powell was asked during his press conference if the Fed will have to respond more rapidly to the potential impact of tariffs on U.S. inflation. “There are many factors that can go into determining how tariffs can impact inflation,” he said. “It’s very premature to conclude. We don’t know what tariffs, for how long, how broadly, whether there will be retaliation and what pass throughs into inflation may occur.”
Derek Holt, vice-president and head of capital markets economics at Scotiabank, wrote to investors that: “Data is showing more resilient pressures against central bank policy goals and the incoming U.S. administration poses high risk to the outlook that is making central bankers — and markets — considerably more nervous… I thought Powell’s responses were one part reasonable, one part highly political.”