The Fed decision is expected to feature a rate cut and a lot more. Here’s what to expect
As the Federal Reserve prepares for its third straight rate cut on Wednesday, it is also firing a warning shot of things to come.
After a period of considerable indecision about which direction central bank policymakers would take, markets settled on the quarter-point cut. If that’s the case, it would lower the Fed’s key interest rate to a range of 3.5%-3.75%.
But there are complications.
The Federal Open Market Committee, which sets rates, is divided between members who favor cuts to prevent further weakness in the labor market and members who think the easing goes far enough and threatens to worsen inflation.
Therefore the term “hawk slaughter” became the most popular term of this meeting. In market parlance, this means the Fed will taper, but will send the message that no one should hold their breath for the next interest rate.
“The most likely outcome is some sort of hawkish cutback where the cuts are, but the statement and the press conference suggest the cuts could be over for now,” said Bill English, the Fed’s former director of monetary affairs and now a Yale professor.
English expects the message to be: “They’ve made an adjustment and are comfortable where they are and don’t see the need to do anything more in the near term as long as things are going more or less the way they expect.”
Where the entire committee will serve will be stated in the post-meeting statement and at Chairman Jerome Powell’s press conference. Wall Street economic commentators are anticipating a change in the statement from a year ago and wording regarding “the scope and timing of additional adjustments,” which Goldman Sachs expects to reflect “the bar for future cuts will be slightly higher.”
In addition to the rate decision and announcement, investors will also watch for an update to the “dot plot” of individual authorities’ rate expectations; Expectations for gross domestic product, unemployment and inflation, and a possible update to the Fed’s asset purchasing intent; Some expect the committee to switch back to purchases from stemming the flow of maturing bond proceeds.
Many moving parts
As for Powell, “his tone will likely reflect a higher bar at the press conference, and he will likely come to the point of explaining the views of participants who oppose the cut,” Goldman economist David Mericle said in a note.
About that opposition: The October meeting saw two “no” votes on the final statement, from both sides of the rate debate. Mericle said it’s likely to happen again, accompanied by scores of other “soft dissidents” who will represent differing views on the “dot chart” that anonymously shows the rate outlook for each of 19 individual caucus participants, a group of 12 voters.
While Mericle added that there is a “solid case” for a third cut, there are arguments to be made on both sides.
“It’s a tough meeting, so there will probably be a few dissenters,” English said. “It’s often difficult to bring the committee together. There are people with very different views on how the economy works, how politics works, etc. But this moment is particularly worrying for the economy.”
Despite the lack of official government data due to the shutdown, which has since been resolved, While there are signs of flattening in hiring, there are also occasional signals that layoffs are accelerating. Tuesday’s report from the Bureau of Labor Statistics showed little change in job openings in October, but hiring decreased by 218,000 and layoffs increased by 73,000.
On the inflation side, the latest reading of the Fed’s preferred indicator showed the annual interest rate in September at 2.8%; That’s slightly below Wall Street’s forecast but still well above the central bank’s 2% target.
Inflation concerns
Despite President Donald Trump’s objections that inflation is disappearing, inflation has stabilized at best and remains above the Fed’s target at worst, due in part to tariffs implemented under his watch. While Fed officials mostly say they expect the taxes to provide a temporary boost to prices, the difference between the current level and the central bank target is enough to give some economists and policymakers pause.
“Inflation hasn’t gotten back to 2%, so they’re going to have to keep policy somewhat restrictive if they’re going to put downward pressure on inflation,” former Cleveland Mayor Loretta Mester said on CNBC on Tuesday. “Currently, inflation is well above target and this is not just due to tariffs.”
Still, Mester thinks the FOMC will approve another cut on Wednesday.
Like market participants, Mester saw New York Fed President John Williams’ speech on Nov. 21 as a “pretty clear” sign that another cut was coming. Before that, markets had been betting against a rate cut, especially after Powell said so publicly. At his October press conference he said a move in December was “not a foregone conclusion, far from it”.
“I think they’re going to go ahead with this final cut,” Mester said. “I hope they will signal that the economy is thinking the policy is in a good place and they will slow down the cuts because I’m more worried about inflation risk and stickiness.”
Along with the rate questions and the dot plot update, the committee could signal the next step in balance sheet management.
The committee signaled in October that it would halt “quantitative tightening” or allow maturing bond revenues to decline. With continued pressure on overnight funding markets, some market participants expect the Fed to announce that it will continue bond purchases, but not at a pace that would suggest “quantitative easing” or the reverse of QT.
