Federal Reserve Chairman Jerome Powell speaks during a press conference after the Federal Open Market Committee meeting November 6-7, 2024 at the William McChesney Martin Jr. Federal Reserve Building in Washington, DC I will give a lecture at
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Inflation remains above target, the economy is growing at about 3% and the labor market remains strong. Put all this together and it seems like a perfect recipe for the Fed to raise interest rates, or at least keep them on hold.
But that is unlikely to happen when the central bank’s rate-setting body, the Federal Open Market Committee, announces its policy decision on Wednesday.
In fact, futures market traders are pricing in a near certainty that the FOMC will actually cut the benchmark overnight borrowing rate by a quarter of a percentage point (25 basis points). That would bring the rate down to the target range of 4.25-4.5%.
Although market expectations are high, the decision may be subject to unusual scrutiny. According to the CNBC survey, 93% of respondents said they expected a rate cut, but only 63% said it was the right thing to do.
“I would be tempted to say, ‘No rate cuts,'” former Kansas City Fed President Esther George said in an interview on CNBC’s “Squawk Box” on Tuesday. “Let’s wait and see how the data comes in. 25 basis points doesn’t usually make or break where we are, but it’s time to show the market and the public that they’re not paying attention. I think “I’m off the ball with inflation.” ”
To be sure, inflation remains a thorny issue for policymakers.
Although the annual rate has fallen significantly from its 40-year peak in mid-2022, it remains stagnant in the 2.5% to 3% range for most of 2024. The Fed targets inflation at 2%.
The Commerce Department is expected to report on Friday that the Federal Reserve’s preferred measure of inflation, the Consumer Expenditure Price Index, rose 2.5% in November, or 2.9% in core terms excluding food and energy.
Justifying a rate cut in this environment will require skillful communication from Chairman Powell and the committee. Former Boston Fed President Eric Rosengren also recently told CNBC that he would not cut rates at this meeting.
“They’ve been very clear about what their goals are,” George said. “As we look at the inflation statistics coming in, we’re seeing that the slowdown is not continuing in the same way as before. “There is,” he said. “So I think that’s a reason to be cautious and really think about how much policy easing is needed to get the economy back on track.”
Fed officials who have spoken in favor of lowering rates say there is no need for policy to be so restrictive in the current environment and they don’t want to risk damaging the labor market.
Possibility of “hawkish cut”
If the Fed cuts rates, it would be the first time since September that the federal funds rate has been cut completely.
This is a significant amount of relief in a short period of time, but Fed officials have tools at their disposal to signal to markets that future rate cuts will not be so easy.
One of those tools is a dotplot matrix of individual member expectations for interest rates over the next few years. This will be updated on Wednesday with the rest of the economic forecast summary, including unofficial outlooks for inflation, unemployment and gross domestic product.
Another tool is to use guidance in post-meeting statements to indicate where the committee sees policy direction. Finally, Powell could use the press conference to provide further clues.
The market is most focused on Powell’s negotiations with the media, followed by the dot plot. Powell recently said there is “room to be a little more cautious” about the speed of easing in what the Fed characterizes as a “strong” economy.
“We’re going to see them tilt in the direction of travel to start the process of revising their inflation expectations upwards,” said Vincent Reinhart, chief economist at BNY Mellon and former Fed monetary director for 24 years. said. year. “The score is going to go up a little bit and there’s going to be a lot of interest in the press conference on the idea of skipping the meeting. So it’s going to be a hawkish turn on that front.”
What about Trump?
Mr. Powell is almost certain to be asked about where he will position policy in terms of fiscal policy under President-elect Donald Trump.
So far, the chairman and his colleagues have dismissed questions about the impact of President Trump’s efforts on monetary policy, citing uncertainty about what is being said now and what will materialize in the future. . Some economists think the president-elect’s aggressive plans for tariffs, tax cuts and mass deportations could make inflation even worse.
“Obviously the Fed is in trouble,” Reinhart said. “We used to call this the trapeze artist problem. If you’re a trapeze artist, you can’t leave the platform and swing out until you’re sure your partner has swung out. For central banks, , they can’t actually do that.”Until they are convinced that a change will occur in the political economy, they change their predictions according to what they believe will happen in the political economy. ”
“There’s a lot of interest in the idea of skipping press conferences,” he added. “It will be a hawkish easing in that regard. If (President Trump’s) policies are actually implemented, expectations may move further.”
Other actions on tap
Most Wall Street forecasters expect Fed officials to raise inflation expectations and lower expectations for rate cuts in 2025.
In September, when the dotplot was last updated, officials showed that next year would equate to a quarter-point cut. Markets have already lowered their expectations for easing, with CME Group’s FedWatch indicators showing two rate cuts are expected in 2025 following this week’s policy decision.
There is also a possibility that the Federal Reserve will skip its January meeting. Wall Street expects little change in the statement after the meeting.
Officials are also likely to raise their estimate of a “neutral” interest rate that neither promotes nor suppresses growth. This level has been around 2.5% (2% inflation plus 0.5% at the “natural” level of interest rates) for many years, but has been gradually rising in recent months, with this week’s update at 3%. may exceed.
Finally, the Committee may adjust the interest rate paid on overnight repo operations by 0.05 percentage point as the federal funds rate remains near the lower end of its target range. The “ON RPP” rate acts as a floor for the funds rate and is currently 4.55%, while the effective funds rate is 4.58%. Minutes from the November FOMC meeting indicated that officials were considering a “technical adjustment” to interest rates.
