Wall Street's outlook for interest rate cuts may be too pessimistic.

This week, the Federal Reserve is set to announce its interest rate policy on Wednesday, December 18. The general expectation is for a reduction of 25 basis points, which would lower the effective rate from 4.7% to 4.4%.

However, the more critical aspect of this announcement will be the anticipated trajectory of interest rates for the next year. Market participants are eager to discover whether the Fed still plans to undertake another 100 basis points in cuts next year, as suggested in September, or if the view has shifted to a more hawkish stance (i.e., showing less inclination for easing).

In September, Wall Street was confident that those four rate cuts would occur by the close of 2025. Fast forward to today, and money managers and traders are less assured. The CME Group’s FedWatch tool indicates speculation that the central bank will implement only a 50 basis point reduction next year.

I concur with parts of this assessment. It is likely the Fed will revise down its rate-cut expectations for next year. Recent indicators relating to employment and inflation suggest growth is reverting to pre-pandemic norms, and economic output has not collapsed as some analysts had feared earlier this year. This indicates the Federal Reserve is achieving its goals of full employment and price stability. As a result, I predict a guidance for 75 basis points in rate reductions by 2025, which is more optimistic than Wall Street’s forecast of just 50.

This projection holds importance for risk-asset investors because it signifies that borrowing costs will continue to decline. With more accessible funds, the likelihood of loans increases, encouraging hedge funds to leverage more, resulting in greater available capital for investment. Simultaneously, yields for money market funds and bonds will decrease due to falling interest rates. Consequently, investors will lean towards riskier assets like cryptocurrencies and stocks, driving their prices upwards.

For clarity, the Fed meets eight times annually to set monetary policy. These meetings typically occur at the beginning and end of each quarter, with the second meeting per quarter holding additional significance because it is when the Summary of Economic Projections (SEP) is shared. This forecast acts as a guidepost for policymakers’ economic growth, inflation, unemployment, and interest rates expectations for the upcoming years.

The projections made in September were telling: Fed officials anticipated GDP growth for 2024 to reach approximately 2%, with an unemployment rate around 4.4%, inflation hovering at 2.3%, and borrowing costs stabilizing at 4.4%. The future outlook extends these trends, with estimates indicating interest rates might eventually settle around 2.9%.

Current indicators suggest we are unlikely to align with the earlier projections. Economists expect a 2.2% increase in GDP for the fourth quarter, raising the average growth rate for the year to about 2.4% – above initial expectations.

A similar positive sentiment is reflected in the labor metrics. The unemployment rate currently stands at 4.2%, and recent data on personal consumption expenditures highlights that inflation is at 2.3% year-on-year, validating the anticipated 25 basis point cut this week.

As we examine nonfarm payroll gains, the data indicates an average addition of 180,000 jobs per month in 2024, compared with an average of 177,300 from 2017 to 2019, suggesting the labor market is stabilizing.

Regarding inflation trends, recent figures indicate that the personal consumption expenditures growth shows slower progression in recent months. High early-year numbers from January to April account for 1.3% of the November annualized result of 2.3%. However, in examining the previous six months, annualized inflation growth seems to have decelerated to 1.6%, well below the Fed's 2% target, indicating continued pressure on prices.

Since initiating its rate hikes in March 2022, the Fed has pursued two primary goals: maximum employment and price stability. For a long time, there have been no definitive signs of either scenario being achieved. Nonetheless, current data suggests the labor market has steadied, and price pressures are approaching desired levels.

From 2000 to 2020, the average real interest rate based on personal consumption expenditure stood at -0.05%. Presently, this rate is at 2.6%. If the central bank aims to revert to a neutral position, significant easing still lies ahead.

Overall, the economy maintains a healthy posture, allowing the Fed the luxury of a more calibrated approach to rate cuts moving forward. Such a scenario is indeed favorable, as opposed to rapid cuts when economic output is declining significantly.

In summary, expect the Fed to revise borrowing cost projections for the end of 2025 downward to around 3.7%, compared to prior guidance of 3.4%. This adjustment suggests better-than-anticipated outcomes compared to Wall Street’s outlook of 3.9%, alleviating concerns and potentially facilitating a more stable long-term increase in risk assets like Bitcoin and Ether.