Fed's Interest Rate Outlook by UBS Economists

UBS economists expect the Federal Reserve to deliver an interest rate cut in June, by 25 basis points (bps), followed by another in September.

The Fed recently reduced interest rates by 25 bps at its latest FOMC meeting, matching market expectations. This represents the fourth cut since September, totaling a reduction of 100 basis points, bringing the policy target range to 4.25%-4.5%.

However, the updated dot plot presented a more hawkish stance than anticipated. The median projection now reflects only 50 basis points of cuts for 2025, a significant adjustment from the 100 basis points indicated in the previous September dot plot. This suggests that policy adjustments could potentially extend through 2027.

Markets reacted negatively to this announcement, with equities sharply declining, bond yields rising, and the dollar gaining strength.

During the post-meeting press conference, Fed Chair Jerome Powell expressed optimism regarding the economy and the outlook for 2025. He noted that economic growth had exceeded the Fed's recent expectations, and inflation remains above the 2% target. Consequently, the central bank plans to adopt a more measured approach toward further rate reductions.

UBS senior economist Brian Rose stated, "Our own views on the economic outlook are similar to the Fed's, and we have adjusted our rate cut forecast in line with the new dot plot." The bank now anticipates 25 basis point cuts in both June and September, with a total of 50 basis points forecasted for 2025, down from earlier expectations of quarterly cuts.

While this cautious approach is currently preferable, Rose noted that a March rate cut could be revisited if there are unfavorable labor market reports early next year.

The Fed's hawkish stance supported a rally in the U.S. dollar, with the dollar index briefly exceeding 108. This trend aligns with interest rate movements over the past two years and is expected to persist into 2025.

Political developments, including Donald Trump's forthcoming inauguration, are likely to sustain the dollar's strength in the near term. However, UBS identifies limits to further dollar appreciation, citing overvaluation and minimal expectations for U.S. monetary easing in 2025, alongside the market's focus on the favorable aspects of Trump's policies. Any divergence from these expectations could lead to a dollar pullback.

UBS views current dollar rallies as an opportunity to sell, forecasting the EURUSD to revert to 1.10 later in 2025.