The current market expectations for the Federal Reserve’s actions in 2025 may be more conservative than what UBS analysts predict. While the market is only pricing in a modest 7.5 basis points (bps) of Fed cuts by the March 19 meeting, UBS’s US economists suggest that the likelihood of a more substantial reduction in interest rates is higher than commonly anticipated.

At present, UBS maintains its forecast of 100bps of rate cuts this year, with a likely cut in March. However, there’s a possibility that the first cut could be delayed until May, depending on evolving economic conditions.

The Case for Rate Cuts

UBS’s outlook for rate cuts is rooted in a combination of recent economic data and a shift in the Fed’s approach. While recent reports, such as the payroll data, have been strong, there are key indicators pointing towards a potential cooling in inflationary pressures.

A notable observation comes from the Consumer Price Index (CPI), which shows a step-down in rent growth—a critical component of inflation. Additionally, the core Personal Consumption Expenditures (PCE) index, another closely watched inflation measure, appears to be on a downward trajectory, further supporting the argument for Fed rate cuts.

Furthermore, UBS economists anticipate a significant downward revision of total employment in the annual revisions—around 700,000 jobs—further suggesting that the labor market may not be as robust as previously thought. This would add another layer of evidence for a more dovish Fed stance.

A Shifting Fed Narrative

Since September, the Federal Reserve has adjusted its focus, shifting from concerns over inflation to a stronger emphasis on jobs. By December, the narrative returned to inflation as the primary concern, but UBS believes that as inflation continues to slow, the Fed’s outlook may pivot once again.

The firm notes that the Federal Reserve’s current balance of risks seems tilted towards inflation, but this may soon change. As inflation projections are revised downward and the labor market shows signs of weakness with potential downside risks, UBS expects the Fed to take a more dovish approach.

A Diverging View from the FOMC

The UBS team believes that the Federal Open Market Committee (FOMC) is likely underestimating the potential for rate cuts. With lower inflation projections and a weaker-than-expected labor market, UBS expects more than just two 25bps rate cuts—the amount considered appropriate by the FOMC in its December Summary of Economic Projections (SEP). Given these factors, UBS anticipates a more aggressive approach from the Fed, which could involve larger cuts than the market currently anticipates.

While the market is pricing in only modest cuts, UBS’s view is that there’s a higher chance of significant rate reductions in the months ahead. With inflation slowing and the labor market showing signs of weakness, the Fed’s next move could be more dovish than many expect, and 100bps of cuts this year is far from off the table. As the economic data evolves, the Fed’s stance may shift once again, possibly resulting in a more accommodative policy that could help stimulate the economy as it navigates a changing inflation landscape.