The Federal Reserve began its rate-cutting cycle in September, delivering a massive 50 basis points (bps) cut in interest rates. The move marked a major shift in monetary policy, marking the first rate cut in the United States since 2020.

According to Wells Fargo, the amount of the cut, along with Federal Reserve Chairman Jerome Powell's comment, indicates some concern about the state or direction of the labor market and less concern about inflation.

“Powell indicated during his press conference that the labor market was in a strong place, and the Fed’s rate decision was intended to keep it there,” Wells Fargo strategists said in a recent note.

FOMC members also expect unemployment to rise slightly, to 4.4% in 2024 and 2025, while GDP growth is expected to be 2.0% annually over the same period.

According to Wells Fargo, this indicates that "the labor market is beginning to cool, but not by much."

“It is worth noting that FOMC members also see inflation continuing to decline. We believe this baseline scenario paves the way for rate cuts, but leaves their magnitude in question, especially for the implied rate cuts in 2025.”

However, the Fed’s updated forecasts differ from market expectations. According to the report, the market is pricing in 125 basis points of rate cuts in both 2024 and 2025, which is more aggressive than the Fed’s average forecast of 100 basis points of cuts each year.

“With all but one FOMC participant expecting cuts of 100 basis points or less in 2024, the market could be in for a disappointment,” the strategists continued.

“Market pricing would require at least one additional 50bp cut in 2024 rather than two 25bp cuts, which we do not believe the current labor market situation supports. And based on Powell’s comments, we do not believe the Fed sees that outcome either.”

Looking ahead, strategists remain cautious about market expectations for the Fed’s rate-cutting cycle, calling them “too optimistic.” They note that a total of 200 basis points of cuts through 2025 would likely require a much worse economic environment than they or the Fed currently expect.

“If the economy continues to move toward a gradual slowdown followed by a recovery in the second half of 2025, as we expect, we believe the September cut will likely be the only 50 basis point cut we see this cycle,” the note said.

Also, Wells Fargo analysts believe that inflation could rebound by mid-2025, which could limit the Fed's ability to deliver all of the interest rate cuts it has forecast.

In their view, a more realistic scenario could see additional cuts of 50 basis points in 2024 and 75 basis points in 2025.