Federal Reserve Chairman Jerome Powell speaks during a press conference following the Federal Open Market Committee meeting on November 6-7, 2024 at the Federal Reserve's William McChesney Martin Jr. Building in Washington, D.C.
Andrew Caballero Reynolds | AFP | Getty Images
Inflation is consistently above target, the economy is growing at about 3%, and the labor market is holding up. Put it all together, and it looks like a perfect recipe for the Fed to raise interest rates, or at least stay there.
However, that is not what is likely to happen when the Federal Open Market Committee, the entity that sets the central bank's interest rates, announces its policy decision on Wednesday.
Instead, traders in the futures market are pricing in almost certainty that the FOMC will actually cut its benchmark overnight borrowing rate by a quarter of a percentage point, or 25 basis points. This will bring it down to a target range of 4.25% to 4.5%.
Even with the high level of market expectations, this decision may be subject to an unusual level of scrutiny. A CNBC poll found that while 93% of respondents said they expected the cut, only 63% said it was the right thing to do.
“I would be inclined to say no cut,” former Kansas City Fed President Esther George said Tuesday during an interview with CNBC's “Squawk Box.” “Let's wait and see how the data comes out. Twenty-five basis points usually isn't make or break where we are, but I think this is a good time to signal to the markets and the public that they haven't got their attention. Off the inflation ball.”
Indeed, inflation remains a vexing problem for policymakers.
While the annual rate has fallen significantly from its 40-year peak in mid-2022, it has remained mired around the 2.5% to 3% range through most of 2024. The Fed is targeting inflation at 2%.
The Commerce Department is expected to announce on Friday that the personal consumption expenditures price index, the Fed's preferred measure of inflation, rose in November to 2.5%, or 2.9% on the core reading that excludes food and energy.
Justifying interest rate cuts in that environment will require some skillful communication from Chairman Jerome Powell and the committee. Former Boston Fed President Eric Rosengren also recently told CNBC that he would not cut interest rates at this meeting.
“They are very clear about their target, and as we watch the inflation data come in, we see that it does not continue to slow in the same way as it did earlier,” George said. “So, I think that's a reason to be cautious and really think about how much of this policy easing is needed to keep the economy on track,” he added.
Fed officials who spoke in favor of the cut say that policy does not need to be restrictive in the current environment and that they do not want to risk hurting the labor market.
Opportunity for “Hard Cut”
If the Fed continues with the cut, it will mark a full percentage point cut from the federal funds rate since September.
While this represents a significant amount of easing in a short period of time, Fed officials have tools at their disposal to signal to markets that future cuts will not come so easily.
One such tool is a dot matrix of individual members' expectations of interest rates over the next few years. This will be updated on Wednesday with the rest of the economic outlook summary which will include unofficial forecasts for inflation, unemployment and GDP.
Another tool is to use guidance in a post-meeting statement to indicate the direction in which the committee sees the policy heading. Finally, Powell can use his press conference to provide more evidence.
Powell's dialogue with the media is what the markets will be watching closely, followed by the dot chart. Powell recently said the Fed “can be a little more cautious” about how quickly it eases amid what he described as a “strong” economy.
“We will see them leaning into the direction of travel, to start the process of raising their inflation expectations,” said Vincent Reinhart, chief economist at the Bank of New York and former director of the Fed's monetary affairs division, where he served for 24 years. . “(The points will) go up a little bit, and (there will be) a lot of preoccupation in the press conference with the idea of skipping meetings. So it will be seen that it was tough in this regard.”
What about Trump?
Powell will almost certainly be asked how policy will be set regarding fiscal policy under President-elect Donald Trump.
So far, the president and his colleagues have ignored questions about the impact Trump's initiatives could have on monetary policy, citing uncertainty about what is just talk now and what will become reality later. Some economists believe the next president's plans to impose tough tariffs, tax cuts and mass deportations could worsen inflation further.
“The Fed is clearly in trouble,” Reinhart said. “We used to call it the trapeze artist problem. If you're a trapeze artist, you don't leave your platform to swing until you're sure your partner has swung out. For a central banker, they can't really change their forecasts in response to what they think is going to happen in the political economy until they're absolutely sure that That there will be these changes in the political economy.”
He added: “The main concern in the press conference is the idea of skipping meetings.” He added, “So it will turn out, I think, to be extreme facilitation in this regard. With (Trump's) policies already implemented, they may raise expectations further.”
Other actions on tap
Most Wall Street forecasters see Fed officials raising their inflation forecasts and lowering expectations for rate cuts in 2025.
When the bullet chart was last updated in September, officials indicated the equivalent of four quarter-point reductions in the coming year. Markets have already lowered their expectations for easing, with a projected path of two cuts in 2025 following this week's move, according to CME Group's FedWatch gauge.
Expectations are also for the Fed to skip its January meeting. Wall Street expects little or no change in the post-meeting statement.
Officials are also likely to raise their estimates of the “neutral” interest rate, which neither promotes nor restricts growth. This level has been around 2.5% for years — a 2% inflation rate plus 0.5% at the “normal” interest level — but has crept higher in recent months and could exceed 3% in this week’s update.
Finally, the Committee may adjust the interest it pays on overnight repo operations by 0.05 percentage point in response to the federal funds rate drifting near the bottom of the target range. The ON RPP rate acts as the minimum funds rate and is currently 4.55%, while the actual funds rate is 4.58%. Minutes from the November FOMC meeting indicated that officials were considering a “technical adjustment” to the interest rate.
