Sticky US inflation and Trump tariffs cast doubt on Fed’s rate cut path, say experts

Although US CPI inflation recorded its sharpest increase in seven months, it aligned with forecasts and did not disrupt expectations of a 25 bps rate cut by the US Federal Reserve next week. However, the November inflation data highlighted that the Fed still faces significant challenges in bringing inflation below its 2 per cent target, leaving the outlook for future rate cuts uncertain.

US consumer price index (CPI) rose to 2.7 per cent in November from a year ago, up slightly from 2.6 per cent in October.

Market participants look almost certain that the US Fed will cut rates by 25 bps on December 18. However, the outlook for 2025 is hazy. Experts expect the December policy’s dot plot to reveal fewer cuts for 2025, with labour and GDP data in the US showing resilience.

“The market is nearly certain of a 25bps cut next week, with a 98 per cent probability versus an 89 per cent probability yesterday. While the Fed is almost certain to cut by 25bps next week, the outlook for 2025, with possible tariffs and other inflationary Trump policies, is murkier, which could possibly move the Fed’s terminal rate higher,” said Madhavi Arora, Lead Economist, Emkay Global Financial Services.

The Trump factor

Apart from inflation, the Fed will have to deal with President Donald Trump’s inflationary policies if he decides to implement higher tariffs.

“The trajectory of future rate reductions appears to be less certain. For the past four months, persistent core inflation has maintained a consistent rate of 3.3 per cent year over year. Furthermore, inflation may be subject to upward pressure due to potential policy modifications, including new tariffs and immigration policies likely to be implemented by the incoming administration,” said Sujan Hajra, Chief Economist and Executive Director at Anand Rathi Shares and Stock Brokers.

Anindya Banerjee, SVP and head of currency and commodities at Kotak Securities, also observed that underlying inflationary pressures are building up in the US economy, and if Trump announces higher tariffs, the Fed will find it tough to cut rates further.

“With the economy holding up well, if Trump enacts significantly higher tariffs, it can be difficult for the Fed to reduce rates by a larger amount. Fed may consider the path forward depending on the Trump administration’s policies,” Banerjee said.

Concerns over inflation seem to have refused to fade away. Experts point out that with sticky core services and core commodities inflation making a comeback, the Fed will have limited room to cut going forward.

“We observe a sea-saw in the inflation print. Food, energy, and core commodities are back to rise, even if we saw shelter moderating. If one side is down, another is up. The sea-saw continues without any steady improvement on the headline. While inflation is in line with the estimate and will ensure a rate cut next week, uncertainty lingers on the prospects of a 100 bps cut in 2025. Fed may well take its chance now,” said Anitha Rangan, Economist, Equirus.

Rangan expects the Fed to deliver a hawkish cut while rates could rise further.

“After a 75 bp cut, with a shift in regime looming, the Fed could risk another 25 bps. Fed could take the chance but tone down the pace of further cuts in their dot plot and deliver a balancing act while rates could rise further. With tariff uncertainties, along with an elevated fiscal deficit, which only looks to rise further at this point (nearly 6 per cent at least for a decade), inflation could remain sticky or even rise with less probability towards the 2 per cent goal,” said Rangan.

Expect high volatility

Experts believe the market could face heightened volatility due to uncertainty surrounding the trajectory of the Fed’s rate cut, Trump’s tariff plans, and the US fiscal deficit.

Rangan says investors should brace for higher rates and volatility in the global and local markets, given the heightened uncertainty in the coming months related to trade, tariffs, inflation and fiscal deficits.

“Tariffs, inflation and fiscal deficits will take centre stage as US debt ceiling reinstatement comes on Jan 1, 2025. Even if everything else remains the same, with the debt ceiling, the noise around US fiscal deficits will take centre stage in January, and the Fed, in acknowledgement of the uncertainty, could likely pause going forward,” said Rangan.

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