- Source: npr.org
The Fed interest rate decision is set to be significant, sparking anticipation and debate over its next steps in managing the U.S. economy. With inflation remaining above target, economic growth at approximately 3%, and a resilient labor market, many would assume the central bank might either raise interest rates or keep them steady. However, market expectations suggest otherwise.
Traders in the futures market are nearly certain that the Federal Open Market Committee (FOMC) will lower its benchmark overnight borrowing rate by a quarter percentage point, or 25 basis points, bringing it to a target range of 4.25% to 4.5%. This potential rate cut would mark a notable shift in monetary policy, drawing considerable scrutiny from economists, policymakers, and financial markets alike.
Inflation Remains a Persistent Challenge
Despite recent progress, inflation continues to challenge policymakers. While the annual inflation rate has significantly dropped from its 40-year peak in mid-2022, it has been hovering in the 2.5% to 3% range for most of 2024. This remains above the Fed’s long-term target of 2%. On Friday, the Commerce Department is expected to report that the personal consumption expenditures price index, the Fed’s preferred inflation gauge, increased slightly to 2.5% in November. Core inflation, which excludes volatile food and energy prices, is projected to rise to 2.9%.
This inflationary environment complicates the justification for a Fed interest rate cut. Some former Fed officials have expressed caution, arguing that the Fed should maintain its current stance and observe additional data before making any adjustments.
Balancing Act Between Inflation and Growth
Advocates for a rate cut argue that the current economic environment no longer requires such restrictive policies. While inflation is still a concern, the Fed should avoid tightening too much and potentially harming the labor market or economic growth. If the FOMC proceeds with the expected cut, it will mark a full percentage point reduction in the federal funds rate starting in September.
Fed Chair Jerome Powell and the committee face the delicate task of communicating their rationale for the cut while ensuring markets understand that further easing will not come easily. Powell recently emphasized the need for caution, stating that the Fed can afford to ease policy gradually in light of the strong economy.
Tools to Signal Future Policy
To manage market expectations for the Fed interest rate, the Federal Reserve has several tools at its disposal. One key indicator will be the updated dot plot, which outlines individual members’ expectations for interest rates over the next few years. Alongside this, the Summary of Economic Projections will provide updates on inflation, unemployment, and GDP forecasts.
Additionally, the post-meeting statement will offer guidance on the committee’s policy outlook, while Powell’s press conference will be closely watched for further insights. Economists predict that Powell will strike a balance between acknowledging current economic strength and cautioning against overestimating the pace of future rate cuts.
Potential for a Hawkish Cut
Many experts believe this week’s Fed interest rate decision could result in what is being termed a hawkish cut. While the rate reduction would signal some easing, the Fed is likely to emphasize that additional cuts will not be forthcoming without clear evidence of sustained economic challenges. Powell may also address the possibility of skipping future meetings or slowing the pace of policy adjustments to ensure inflation remains under control.
Broader Economic Implications
The Fed interest rate decision comes at a time when Wall Street forecasters expect the Fed to raise its inflation expectations while reducing the projected number of rate cuts for 2025. In September, the Fed had signaled the possibility of four quarter-point cuts next year. However, market expectations have since adjusted to anticipate only two cuts in 2025, following this week’s potential move.
Additionally, the Fed may update its estimate for the neutral rate of interest—the level at which policy neither stimulates nor restricts growth. This rate, previously set at around 2.5%, has likely risen in recent months and could exceed 3% in this week’s update.
Finally, the committee might implement a technical adjustment to the interest paid on overnight repo operations, increasing the rate slightly to address the federal funds rate drifting near the lower end of its target range.
Looking Ahead
The Fed interest rate decision will significantly affect financial markets, businesses, and consumers. While the move is widely anticipated, its reasoning and the accompanying messaging will play a crucial role in shaping expectations for future monetary policy. As the central bank navigates a complex economic landscape, it remains focused on balancing its dual mandate of controlling inflation and supporting employment.