Federal Reserve Chair Jerome Powell and the Federal Open Market Committee (FOMC) will announce their latest monetary policy decision on Wednesday, and market participants are preparing for a surprising move. Despite inflation remaining above the Fed's 2% target, robust economic growth of around 3% and a strong labor market, the central bank is expected to lower its benchmark interest rate by 25 points basis, bringing the target range to 4.25%-4.5. %.
This potential cut comes as a surprise to many, as conventional wisdom would suggest that the Fed might maintain or even raise rates under such economic conditions. Futures market data reflects the near certainty of a rate cut, but the decision has sparked considerable debate. A CNBC poll found that while 93% of respondents expect a cut, only 63% believe it is the right course of action.
Former Kansas City Fed President Esther George expressed skepticism about the move during a recent interview on CNBC's “Squawk Box.” He stressed the need for caution, suggesting the Fed should postpone rate cuts until more data becomes available. “Twenty-five basis points doesn't usually determine where we are,” George said. “But I think it's time to signal to the markets and the public to pay attention beyond just the inflation numbers.”
Inflation remains a challenge
Inflation, while significantly below its 40-year peak in mid-2022, has remained stubbornly hovering between 2.5% and 3% throughout 2024. This remains above the Fed's 2% target, lifting doubts about the appropriateness of easing monetary policy.
On Friday, the Commerce Department is expected to release data on the personal consumption expenditure (PCE) price index, the Fed's preferred inflation gauge, which is expected to show an overall increase of 2.5% and a rise of 2. 9% of core inflation (excluding food and grocery items). energy).
Justifying a rate cut in this environment will require strategic communication from Powell and the FOMC. Former Boston Fed President Eric Rosengren recently expressed his concerns, arguing that the Fed's inflation-fighting mission is far from over. “Inflation is not decelerating as it has in the past,” Rosengren said, adding that this should give the Fed pause before moving toward more accommodative policy.
Balancing economic risks
Supporters of the planned rate cut argue that monetary policy no longer needs to be so restrictive given the current economic environment. While inflation remains a concern, they believe the risk of the strong labor market stalling outweighs the potential dangers of easing too early.
If the Fed goes ahead with the cut, that would represent a full one percentage point rate cut from September – significant easing in a short amount of time. However, Powell and the FOMC will likely signal that further cuts will not come easily.
One mechanism for managing market expectations is the dot plot, which outlines individual FOMC members' rate projections for the next few years. The updated dot plot, together with the summary of economic projections (including forecasts for inflation, unemployment and GDP), will be published together with the policy decision. Powell is also expected to use his post-meeting press conference to provide further context and guidance.
The concept of “hawk cut”
Analysts expect the Fed's language and tone to reflect a “hawkish cut,” or a reduction in interest rates accompanied by strong signals that the central bank remains vigilant about inflation and is not embarking on an aggressive easing cycle .
Vincent Reinhart, chief economist at BNY Mellon and a former Fed official, believes Powell will emphasize caution in his remarks. “The graph will move slightly higher and Powell will emphasize the importance of skipping meetings for future cuts,” Reinhart said. “This suggests a careful and deliberate approach, reinforcing the Fed's commitment to price stability.”
Powell himself recently hinted at this cautious attitude, saying that the Fed “can afford to be a little more careful” about easing monetary policy in a context of a strong economy.
The Trump factor: potential implications for fiscal policy
Another question hanging over the Fed's decision is the potential impact of fiscal policy under President-elect Donald Trump. Powell is almost certain to face questions about how Trump's proposed economic initiatives – such as aggressive tariffs, broad tax cuts and mass deportation policies – might affect monetary policy.
Powell and other Fed officials have so far avoided speculating on Trump's plans, citing uncertainty over which proposals will materialize. Economists warn that some of these policies could exacerbate inflationary pressures, complicating the Fed's job.
Vincent Reinhart compared the Fed's situation to that of a trapeze artist waiting for his partner to stabilize the swing. “The Fed cannot change its forecasts based on political speculation,” Reinhart said. “They need enough confidence that policy changes will actually happen before they react.”
Future adjustments and expectations
Looking ahead, most Wall Street analysts expect the Fed to raise its inflation forecasts and reduce the expected number of rate cuts for 2025. In September, the dot plot suggested four cuts were likely quarter points next year. However, markets now expect just two cuts in 2025 after this week's expected move.
There is also a strong possibility that the Fed will skip its January meeting, leaving little room for immediate policy changes in early 2025.
Furthermore, the FOMC could revise its estimate of the “neutral” interest rate, i.e. the rate that neither stimulates nor limits economic growth. For years this rate has hovered around 2.5%, but recent developments suggest it could exceed 3% in the next update.
Finally, the Fed may make a technical adjustment to the interest rate on overnight reverse repurchase agreements (ON RRPs). This rate currently serves as the floor for the federal funds rate and is slightly lower than the actual funds rate. A 0.05 percentage point adjustment could help align rates more closely.
What is the future of the Fed?
The Fed's decision this week will likely set the tone for monetary policy in 2025. Although a rate cut appears imminent, the central bank is expected to emphasize its cautious approach, balancing the need to support economic growth with its commitment constant in controlling inflation.
As markets closely monitor Powell's press conference and updated dot plot, the Fed's communications strategy will be critical in managing expectations. Whether this week's move is seen as a step toward easing or a cautious recalibration, it will undoubtedly shape the economic narrative for months to come.
