First Fed rate cut in 2025: New data, new expectations

On September 17, the Federal Open Market Committee (FOMC) of the Federal Reserve (Fed) voted, by majority vote, to reduce the federal funds rate by 25 basis points, to a range of 4.0-4.25 percent. The only dissenting vote was Stephen I. Miran, who voted for a 50 basis point cut.

The statement reaffirmed the Committee's assessment of the evolution of economic activity, noting that growth has moderated according to recent indicators.

On this occasion, the assessment of the labor market was modified, as it was noted that while the unemployment rate remains low, it has also increased.

The comment that the labor market remains strong was also removed and replaced with a comment that job creation gains have slowed. The comment that inflation remains somewhat elevated was once again endorsed, adding that it has accelerated.

Headline inflation, measured by the CPI, was 2.9% in August, although the core component was 3.1%. However, PCE inflation was 2.6% in July, although the core component was 2.9%.

In this regard, it is important to consider that both inflation indicators have shown increases since May.

For this reason, while inflation has not returned to the levels observed between mid-2021 and mid-2023, it has accelerated and approached levels close to 3%. The Federal Reserve's projections for 2025 include inflation of 3.0%, while for 2026 it is still projected to be 2.6%.

While there are numerous estimates of the US neutral real rate (the so-called "r-star"), this variable is expected to range between 0.8% and 1.4% in the coming months.

Therefore, the current levels of the reference rate, combined with the Federal Reserve's inflation forecasts for next year, imply that the current ex-ante real rate is between 1.4 and 1.65%; that is, the ex-ante real rate is currently slightly above the neutral real rate.

However, the weak labor market has pressured the Committee to lower interest rates more than initially planned this year.

This poses a significant risk, because if inflation does not moderate and nominal rates continue to be reduced, what could initially have been characterized as a supply shock could very well generate an acceleration in aggregate demand that would pressure inflation and lead to the beginning of a contamination of longer-term inflation expectations, which would further slow convergence toward the 2 percent target.

There is also one effect that has been a notable focus of the discussion: the boost that expectations of further reductions in benchmark rates have provided to the valuations of securities listed on the stock markets.

At the close on September 18, 2025, the S&P 500 closed at 6,631.96, its all-time high; the Nasdaq Composite reached 22,470.73, also a record high. In the Mexican market, the S&P/BMV IPC index reached a record high on September 15, 2025, when it closed at 62,102.13; while the FTSE-BIVA index also reached a record high that day, closing at 1,244.10.

In this regard, it should be noted that numerous publicly traded issuers have shown significant progress in their valuations.

Some of them have already reached or even surpassed target prices, while others are still lagging behind.

In this sense, it is advisable to be more cautious and selective, because while current valuations respond to expectations of lower interest rates in the near future and good financial results in the coming quarters, it is also true that new employment and inflation data that are released will contribute to shaping new expectations and, with it, new valuations.