The Fed is on track to cut interest rates in December, but no one knows what will happen next

Friday’s jobs report effectively solidified the view that the Fed will approve a rate cut when it meets later this month. Whether you should do so and what to do from there is another question.

The neither-too-hot nor too-cold nature of November’s non-farm payrolls release gave central banks the space they needed, and markets responded similarly by raising the implied probability of cuts to nearly 30%. 90% according to CME Group standards.

But central banks are likely to face intense debate in the coming days over how quickly and to what extent they should take action.

“Financial conditions have eased significantly. The Fed’s risk here is creating speculative bubbles,” Joseph LaVogna, chief economist at SMBC Nikko Securities, said on CNBC’s “Squawk Box” after the report’s release. That’s true.” “There is no reason to cut rates at this point. There should be a pause in rate cuts.”

La Bogna, who served as a senior economist during President Donald Trump’s first term and could return to the White House, was not alone in his skepticism about the Fed’s interest rate cuts.

Chris Rupkey, senior economist at FWDBONDS, wrote that the Fed “doesn’t need to play around with stimulus packages because jobs are plentiful,” and that the central bank’s stated intention to continue lowering rates “will become increasingly prudent as policy progresses.” “It looks like it’s no longer the case,” he added. The flames of inflation have not been extinguished. ”

Jason Furman, himself a former White House economist under President Barack Obama, appeared on CNBC with LaVogna and expressed alarm, especially about inflation. Furman noted that the recent pace of average hourly wage increases is more in line with the 3.5% inflation rate, rather than the 2% the Fed wants.

“This is another data point in a no-land scenario,” Furman said of the jobs report, using the term to describe an economy that continues to grow but causes more inflation.

“I have no doubt that the Fed will cut rates again, but no one knows when they will cut rates beyond December. That will require further increases in the unemployment rate,” he added.

In the meantime, policymakers will need to sift through vast amounts of information.

First things first: November’s jobs report showed an increase of 227,000 jobs, which was slightly better than expected and a significant increase from October’s meager 36,000 jobs. Combined, the two-month period (October was hit by Hurricane Milton and the Boeing strike) averaged 131,500 jobs, slightly down the trend since April, when the labor market first started to become unstable. has fallen below.

However, despite a 4.2% rise in the unemployment rate due to a decline in household employment, the employment situation still looks solid, if not spectacular. Salaries have not decreased for a single month since December 2020.

However, there are other factors as well.

Inflation has recently begun to accelerate, with the Fed’s preferred measure rising to 2.3% in October, or 2.8% excluding food and energy prices. Wage growth also continues to be strong, with the current 4% easily exceeding pre-COVID-19 levels going back at least to 2008. Then there’s the question of fiscal policy at the start of President Trump’s second term and whether his plans to impose punitive tariffs will come to fruition. further accelerate inflation.

Meanwhile, the overall economy is growing strongly. According to the Atlanta Fed, gross domestic product (GDP) is expected to grow at an annualized rate of 3.3% in the fourth quarter.

There is also the issue of “financial conditions,” including yields on government bonds and corporate bonds, stock prices, and mortgage interest rates. Fed officials believe the current overnight borrowing rate range of 4.5% to 4.75% is “restrictive.” But by the Fed’s own metrics, financial conditions are the easiest they’ve been since January.

Earlier this week, Federal Reserve Chairman Jerome Powell praised the U.S. economy as the envy of the developed world, saying it provided policymakers with a slow-moving cushion as they readjusted policy.

In remarks Friday, Cleveland Fed President Beth Hammack pointed to strong growth and said she needed more evidence that inflation was on track convincingly toward the Fed’s 2% target. Hammack urged the Fed to slow its pace of rate cuts. If December’s reduction is implemented, it will be the first reduction since September.

“We have reached a point where it makes sense to slow the pace of rate cuts, balancing the need to maintain a suitably restrictive stance on monetary policy with the possibility that policy is not far from neutral,” Hammack said. I think it’s at or close to that.” , a voting member of this year’s Federal Open Market Committee.

The only thing left on paper that could dissuade the Fed from cutting rates in December is that separate reports on consumer and producer prices will be released next week. The consumer price index is expected to rise by 2.7%. Starting Friday, Fed officials will enter a quiet period in which they do not give policy speeches before their meetings.

The issue of a “neutral” interest rate that neither suppresses nor promotes growth is central to how the Fed conducts policy. Recent indications are that that level may be higher than in previous economic conditions.

Tom Porcelli, chief U.S. economist at PFIM Fixed Income, said the most the Fed could do is cut rates in December, as traders expect, skip January, and perhaps take a break in early 2025. He said he would likely cut rates one more time before taking action.

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

Mr. Powell and his fellow policymakers said that while they used to focus on prices, they are now paying equal attention to controlling inflation and supporting the labor market.

“If you wait until you see cracks from a labor market perspective and then start adjusting policy downwards, it’s too late,” Porcelli said. “So if you’re smart, I recommend starting that process now.”