The Fed is on track to cut interest rates in December, but what happens next is anyone's guess

Friday's jobs report confirms that the Fed will agree to a rate cut when it meets later this month. Whether it should, and what to do from there, is another matter.

The neither too hot nor too cold nature of November's nonfarm payrolls report gave the central bank any remaining room it might need to act, and the market responded in kind by raising the implied probability of a cut to nearly 90%, according to a CME Group gauge. .

However, in the coming days the central bank is likely to face intense debate over how fast and how far to go.

“Financial conditions have deteriorated significantly. What the Fed is risking here is creating a speculative bubble,” said Joseph LaVorgna, chief economist at SMBC Nikko Securities, speaking on CNBC's “Squawk Box” after the report was released. “There is no reason to cut interest rates right now. They should pause.”

LaVorgna, who served as a top economist during Donald Trump's first term and could serve in the White House again, was not alone in his doubts about a Fed cut.

Chris Rupke, chief economist at FWDBONDS, wrote that the Fed “does not need to adjust measures to boost the economy because jobs are plentiful,” adding that the central bank’s stated intention to continue cutting interest rates appears “increasingly unwise with the fire yet to be extinguished.” Inflation.”

In an appearance with LaVorgna on CNBC, Jason Furman, a former economist in Barack Obama's White House, also expressed caution, especially on inflation. Furman noted that the recent pace of average hourly wage increases is more consistent with the 3.5% inflation rate, rather than the 2% the Fed prefers.

“This is another data point in a no-drop scenario,” Furman said of the jobs report, using a term for an economy in which growth continues but also leads to more inflation.

He added: “I have no doubt that the Fed will cut interest rates again, but when the Fed cuts again after December is anyone's guess, and I think it will take a further increase in unemployment.”

Meanwhile, policymakers will have a wealth of information to draw from.

To start: November payrolls data showed an increase of 227,000, which was slightly better than expected and a big step up from October's 36,000. Adding the two months together — an October hampered by Hurricane Milton and the Boeing hit — the average stands at 131,500, or just below the trend since the job market first began to wobble in April.

But even with the unemployment rate rising to 4.2% amid declining family employment, the jobs picture still looks strong if not stunning. And salaries still haven't decreased in a single month since December 2020.

But there are other factors.

Inflation has begun to rise recently, with the Fed's preferred measure rising to 2.3% in October, or 2.8% when food and energy prices are excluded. Wage gains also continue to be strong, with the current 4% easily exceeding the pre-Covid period dating back to at least 2008. Then there is the question of Trump's fiscal policy as he begins his second term and whether his plans to issue punitive tariffs will succeed. And fueling inflation even further.

At the same time, the broader economy was growing strongly. The fourth quarter is on track to record a 3.3% annual growth rate for gross domestic product, according to the Federal Reserve Bank of Atlanta.

There's also the issue of “financial conditions,” a measure that includes things like Treasury and corporate bond yields, stock market prices, mortgage rates and the like. Fed officials believe the current range of 4.5% to 4.75% for the overnight borrowing rate is “restricted.” However, by the Fed's own measures, financial conditions are at their worst since January.

Earlier this week, Federal Reserve Chairman Jerome Powell praised the US economy, calling it the envy of the developed world and saying it provides a cushion for policymakers to move slowly while resetting policy.

In remarks Friday, Cleveland Fed President Beth Hammack pointed to strong growth and said she needs more evidence that inflation is moving convincingly toward the Fed's 2% target. Hammack called on the Federal Reserve to slow the pace of interest rate cuts. If the cut was implemented in December, it would equate to a decline of a full percentage point since September.

“Balancing the need to maintain a modestly restrictive stance on monetary policy with the possibility that policy will not be too far from neutral, I believe we are at or near the point where it makes sense to slow the pace of interest rate cuts,” Hammack said. , a voting member this year of the Federal Open Market Committee.

The only thing left on the agenda that could dissuade the Fed from cutting rates in December is the release of separate reports next week on consumer and producer prices. The Consumer Price Index is expected to show a rise of 2.7%. Fed officials enter a quiet period after Friday when they will not deliver policy speeches before the meeting.

The issue of a “neutral” rate that neither constrains nor enhances growth is central to how the Fed will conduct policy. Recent indicators suggest that the level may be higher than in previous economic climates.

What the Fed could do is enact a December cut, skip January, as traders expect, and perhaps cut again in early 2025 before taking a break, said Tom Porcelli, chief US economist at PFIM Fixed Income.

“I don't think there's anything in today's data that would actually prevent them from cutting in December,” Porcelli said. “When they raised rates as much, it was for a very different inflation regime than we have now. So in that context, I think Powell would like to continue the policy normalization process.”

Powell and his fellow policymakers say they now give equal attention to controlling inflation and supporting the labor market, whereas previously the focus was more on prices.

“If you want to see cracks from a labor market perspective and then start adjusting policy, it's too late,” Porcelli said. “So wisdom suggests you start this process now.”