Among the factors increasing inflationary expectations are concerns that President Trump’s tax policies may increase the deficit.

The Fed’s decision to cut interest rates by 25 basis points, while talking quite a bit more cautiously about next year was not entirely unexpected, even if it appeared more than a little inconsistent. Inflation is continuing to fall towards the Fed’s two percent target, so let’s reduce rates! Or maybe it isn’t, so let’s warn that there might well be fewer cuts than expected next year.

Writing in the Wall Street Journal, Joseph Sternberg notes that the Fed has now acknowledged that inflation has proved more stubborn than it was forecasting until very recently and that rates have now come down a long way (100 bp) from the post-pandemic peak. Declaring a premature victory over inflation is hardly unprecedented, but that could be what the Fed has done with this most recent cut. That the Fed median expectation for inflation by the end of 2025 has risen from 2.1 percent in September to 2.5 percent today is not reassuring. 2 percent? Not until the end of 2027.

The Fed may have made it easier to slip into overconfidence by, to use Sternberg’s word, “yammering” too much:

If the Fed hadn’t devoted so much energy to head-faking investors with forward guidance promising to do things the central bank shouldn’t do, those investors would have been warning the officials that inflation remains far from whipped. Were officials to yammer less at the markets, investors would be free to place meaningful bets about future inflation and send meaningful price signals about what the Fed should do in response. This is what long-bond investors, who increasingly seem to despair of forward guidance, have already done. They’ve pushed up yields since September in exasperated anticipation of inflation to come.

Ten-year yields have been (with one significant interruption) rising since the rate cut in mid-September. They troughed at about 3.62 percent then, and are now about 4.55 percent (there are plenty in the market who are now eyeing 5 percent). Some of the rise immediately after that earlier cut was of no great significance. That it continued, as I wrote in late October, was worth noting. Investors in the stock markets are paying some attention too, thus the sell-off in the last couple of days (admittedly, after a strong run).

Among the factors increasing inflationary expectations are concerns that President Trump’s tax policies may increase the deficit. We will never know, of course, whether they will do that by any more than Harris’s policies might have done. Whoever had won, concerns over the debt and the deficit would have continued to weigh, sometimes in the foreground, sometimes in the background, but always there. That’s not going to change any time soon and will, obviously, exert some upward pressure on rates. It may well not be the only factor to do so.

There is rather less science in establishing the famous (or infamous) neutral rate, r*, to use the jargon, which neither stimulates nor restricts growth, than some claim. Another factor that may push r* up might be the financing needs of the energy “transition,” although the outlook for that may now be less ambitious (more realistic) than in the past. What does seem as clear as anything is clear is that the ultra-low rates of recent years are not coming back. Given the way they distorted prices, that’s not the worst thing, but it’s bad news for the battered office property market, where re-financings at higher interest rates push down valuations, a blow not only to commercial real estate companies, but those that lend to them.