The Fed has a big interest rate decision on Wednesday. What to expect
Federal Reserve Chairman Jerome Powell in Washington, William McChesney Martin Jr. Speaking during a press conference after the Federal Open Market Committee meeting on November 6-7, 2024 at the Federal Reserve Board Building.
Andrew Caballero-Reynolds | AFP | Getty Images
Inflation is stubbornly above target, the economy is growing at around 3% and the labor market is strengthening. Put it all together, and it sounds like a perfect recipe for the Federal Reserve to raise interest rates, or at least keep them unchanged.
That’s not what’s likely to happen when the Federal Open Market Committee, the central bank’s rate-setting body, announces its policy decision on Wednesday.
Instead, futures market traders are pricing in near certainty that the FOMC will actually cut the overnight borrowing rate by a quarter of a percentage point, or 25 basis points. That would bring it down to the target range of 4.25% to 4.5%.
Even with high market expectations, this can be a decision subject to an extraordinary level of scrutiny. A CNBC survey While 93% of respondents said they expected layoffs, only 63% said it was the right thing to do.
“I would be inclined to say ‘uninterruptible,'” former Kansas City Fed President Esther George said during an appearance on CNBC on Tuesday.Squawk box” Interview. “Let’s wait and see how the data comes in. Twenty-five basis points doesn’t usually make or break where we’re at, but I think it’s time to let the markets and the public know they’re not. they took their eyes off the ball of inflation.”
Inflation, indeed, remains a serious problem for policymakers.
Although the annual rate has fallen significantly from its 40-year peak in mid-2022, 2.5% – 3% has turned into swamp For most of 2024. The Fed is targeting inflation at 2%.
The Ministry of Commerce is expected to inform about it on Friday personal consumption expenditure price indexThe Fed’s preferred inflation gauge rose to 2.5% in November, or 2.9% in the core reading, which excludes food and energy.
Justifying a rate cut in this environment will require some skillful communication from the Chair Jerome Powell and the committee. Former Boston Fed President Eric Rosengren also recently told CNBC that he would not be cut at the meeting.
“They’re very clear about what their targets are, and as we watch the inflation data come in, we see that it’s not continuing to slow down as much as it has,” George said. “So I think it’s a reason to be cautious and think about how much of this easing of policy is required to keep the economy on track.”
Fed officials, who favor exports, say policy doesn’t need to be too restrictive in the current environment, and they don’t want to risk hurting the labor market.
A chance to “falconry”.
If the Fed follows through on the cut, it would drop a full percentage point from the federal funds rate starting in September.
While this is a notable easing in the short term, Fed officials have the tools at their disposal to signal to markets that further tapering will not come so easily.
One such tool is a point-by-scene matrix of individual members’ rate expectations over the next several years. It will be updated on Wednesday along with the rest of the Summary of Economic Projections, which includes unofficial forecasts for inflation, unemployment and gross domestic product.
Another tool is to use guidance in a post-meeting statement to indicate where the committee is heading for policy. Finally, Powell could use the press conference to drop more hints.
What markets will be watching most closely is Powell’s conversation with the media, followed by the dot plot. Powell recently said the Fed “could afford to be a little more cautious” about how quickly it eases in what he described as a “strong” economy.
“We’re going to see them tilt to the direction of travel to start the process of raising their inflation forecasts,” said Vincent Reinhart, chief economist at BNY and former director of the Fed’s Monetary Affairs Department, where he worked for 24 years. . “The points are going to be pushed up a little bit, and there’s going to be a lot of preoccupation with the idea of ​​missing meetings at (the) press conference. So it’s going to be a clear cut in that regard.”
And Trump?
Powell is almost certain to be asked about how President-elect Donald Trump will take a policy stance on fiscal policy.
So far, the chairman and his colleagues have brushed aside questions on the topic Trump’s initiatives may have an impact on monetary policy, based on the uncertainty of what is being talked about now and what will be realized later. Some economists believe the new president’s plans for aggressive tariffs, tax cuts and mass deportations could worsen inflation.
“Obviously, the Fed is closing,” 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 stepped aside. For a central bank, they can’t really do that in response to what they believe will happen in the political economy until they’re absolutely sure that these changes will happen in the political economy.” change their predictions.”
“There’s a lot of focus in the press conference on the idea of ​​missing meetings,” he said. “So I think it’s going to be a hawkish easing on that. As (Trump’s) policies are actually being implemented, they could increase the forecast even more.”
Other actions in the faucet
Most Wall Street forecasters see Fed officials raising their inflation expectations and lowering expectations for a rate cut in 2025.
When the dot plot was last updated in September, officials said it equated to four quarters of dot cuts next year. According to CME Group’s FedWatch measure, markets have already lowered their expectations for an easing by two cuts in 2025 after this week’s action.
It is also predicted that the Fed will miss its January meeting. Wall Street expects little or no change in the post-meeting statement.
Officials will also raise their estimate of a “neutral” interest rate, which neither boosts nor constrains growth. That level has been around 2.5% for years – at a 2% inflation rate and 0.5% at the “natural” interest rate – but has risen in recent months and could pass 3% at this week’s update.
Finally, the committee could adjust the interest rate it pays on overnight repos by 0.05 percentage points, which would be closer to the bottom of the target range for the fed funds rate. The “ON RPP” rate serves as the base for the funds rate and is currently 4.55%, while the effective funds rate is 4.58%. Minutes of the November FOMC meeting indicated that officials were considering a “technical adjustment” to the exchange rate.
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