Key Takeaways
- San Francisco Fed President Mary Daly’s forecast of two potential interest rate cuts in 2025 signals a base case for policy normalisation, but this view represents a centrist position within a divided Federal Open Market Committee (FOMC).
- The Federal Reserve is navigating conflicting economic data: moderating headline inflation and a cooling labour market are countered by persistent underlying price pressures, particularly in services.
- Financial markets are pricing a path for rates that is often more dovencheese than the Fed’s official projections, creating a potential source of volatility if the central bank holds a firmer line than anticipated.
- The primary risk is not a simple binary outcome of cuts or no cuts, but a policy error where the Fed either eases prematurely, reigniting inflation, or holds rates high for too long, precipitating an unnecessary economic downturn.
Recent commentary from Federal Reserve officials, notably San Francisco Fed President Mary Daly, has sketched a potential path for monetary policy that includes two rate reductions in 2025. This forward guidance offers a glimpse into the central bank’s thinking as it navigates the delicate transition from a restrictive stance to a more neutral one. Yet, this projection is far from a foregone conclusion; it represents a single, centrist viewpoint within a committee grappling with conflicting economic signals and divergent opinions on the appropriate timing for easing.
One Voice Among Many
It is crucial to contextualise President Daly’s remarks within the broader spectrum of the FOMC. Her outlook for two cuts is a moderate one, nestled between the more hawkish members who remain wary of premature easing and the dovish contingent concerned about overtightening’s impact on the labour market. The Fed’s most recent Summary of Economic Projections, often called the “dot plot,” reveals this dispersion of views, showing a wide range of expectations among policymakers for the path of the federal funds rate.
Daly herself has stressed that this forecast is a “likely outcome” rather than a firm commitment, emphasising the data-dependent nature of future decisions. She has acknowledged the risks of waiting too long to adjust policy, which could unnecessarily hamper the economy, but also the persistent threat from inflation. This balanced rhetoric underscores the central challenge: determining if inflation is sustainably on a path to the 2% target, thereby allowing the policy focus to shift towards the employment side of the dual mandate.
The Data Conundrum
The Fed’s caution stems from an economic picture that provides evidence for both hawks and doves. While headline inflation has moderated significantly from its peaks, underlying measures show a stubborn persistence that justifies a patient approach. The path from 3% to 2% inflation is widely considered more arduous than the journey from 9% to 3%.
Recent data illustrates this tension. The labour market, while still robust by historical standards, is showing clear signs of normalisation, with a gradual rise in the unemployment rate and a moderation in wage growth. Conversely, core inflation, particularly in the services sector ex-housing (often termed “supercore”), has remained elevated, fuelling concerns that domestic demand is still too strong to guarantee a return to the inflation target.
| Economic Indicator | Recent Reading (Latest Available) | Prior Trend | Implication for Fed Policy |
|---|---|---|---|
| Core PCE Price Index (YoY) | 2.8% | Decelerating, but above target | Supports a “higher for longer” stance |
| Unemployment Rate | 3.9% | Gradually increasing from historic lows | Builds case for eventual easing to support labour market |
| Services Inflation (CPI, ex-energy) | 5.2% | Remains stubbornly elevated | Primary concern for hawkish policymakers |
Market Expectations vs. Fed Guidance
Financial markets perpetually attempt to front-run monetary policy, and the current environment is no exception. Interest rate futures markets, as tracked by instruments like the CME FedWatch Tool, often price in a more aggressive easing cycle than Fed officials are publicly countenancing. This divergence creates a precarious setup. If the economic data forces the Fed to adhere to a slower, more deliberate pace of cuts, markets could be forced into a hawkish repricing, leading to a rapid tightening of financial conditions, volatility in equity markets, and a strengthening of the US dollar.
This dynamic places a premium on Fed communication. Every speech and data release is scrutinised for clues that might resolve this tension. Daly’s commentary, in this light, serves as an anchor, providing a baseline expectation that helps manage market sentiment without tying the committee’s hands.
A Hypothesis for the Path Ahead
For allocators, the situation demands nuance. A simple bet on rate cuts is likely too blunt an instrument. The more pertinent strategy involves positioning for continued uncertainty and potential policy missteps. This could involve favouring high-quality assets that can withstand economic slowing, while maintaining some exposure to rate-sensitive growth sectors that would benefit from eventual easing.
Looking forward, a speculative but plausible hypothesis emerges. The greatest risk may not be that the Fed fails to cut rates, but that the structural drivers of inflation, such as deglobalisation, demographic shifts, and the green energy transition, keep baseline inflation stickier than pre-pandemic models would suggest. In this scenario, the Fed might deliver one or two “insurance” cuts as Daly projects, only to find that inflation re-accelerates from a higher plateau. This would force a painful reversal, shattering market consensus and revealing that the true terminal rate for this economic cycle is substantially higher than anyone currently anticipates. The market is pricing for a soft landing; the underappreciated risk is a landing on a much higher, and rockier, plateau.
References
Investing.com. (2024). Fed’s Daly sees progress on inflation, expects two rate cuts in 2025. Retrieved from https://www.investing.com/news/stock-market-news/feds-daly-sees-progress-on-inflation-expects-two-rate-cuts-in-2025-93CH-4130796
Investing.com. (2024). Fed’s Daly says two rate cuts remain on the table for this year. Retrieved from https://investing.com/news/economy-news/feds-daly-says-two-rate-cuts-remain-on-the-table-for-this-year-4130798
FXStreet. (2024). Fed’s Daly acknowledges that waiting too long could see the Fed lag on rates. Retrieved from https://fxstreet.com/news/feds-daly-acknowledges-that-waiting-too-long-could-see-the-fed-lag-on-rates-202507101901
unusual_whales. (2024, September 12). Fed’s Daly: I see two cuts in 2025 as the likely outcome. [Post]. Retrieved from https://x.com/unusual_whales/status/1825877191814688999
U.S. Bureau of Economic Analysis. (2024). Personal Consumption Expenditures Price Index. Retrieved from BEA.gov.
U.S. Bureau of Labor Statistics. (2024). The Employment Situation. Retrieved from BLS.gov.
U.S. Bureau of Labor Statistics. (2024). Consumer Price Index. Retrieved from BLS.gov.
