Federal Reserve Poised for Another Rate Cut Amidst Political Uncertainty
The Federal Reserve is widely expected to lower its benchmark interest rate by a quarter percentage point at its meeting concluding Thursday. This move, part of the Fed’s ongoing effort to “recalibrate” its policy, comes as inflation shows signs of moderating and the labor market softens. However, the recent stunning victory of Donald Trump in the presidential election introduces significant uncertainty, potentially impacting the Fed’s future trajectory and complicating its already complex task of managing the economy. The upcoming decisions will be closely scrutinized not only for their immediate impact but also for clues about how the Fed intends to navigate the potentially turbulent economic landscape under a Trump administration.
Key Takeaways:
- Rate Cut Imminent: The Federal Reserve is expected to reduce its benchmark interest rate by 0.25 percentage points, bringing the target range to 4.75%-5.0%.
- Political Uncertainty: President-elect Trump's victory introduces considerable unpredictability, potentially impacting future rate decisions due to his proposed policies (tax cuts, increased spending, and potentially protectionist trade measures).
- Inflation and Employment: The Fed will be monitoring inflation and labor market trends closely. Low inflation — currently below 3% — coupled with a softening labor market, complicates the central bank's decision-making process.
- Future Rate Trajectory: Market expectations anticipate further rate cuts in the coming months, but the pace and extent of these reductions remains uncertain, particularly given the political scene.
- Balance Sheet Reduction: The Fed’s ongoing effort to reduce its balance sheet remains a key factor, and the timing of its conclusion could significantly influence upcoming rate decisions.
The Federal Open Market Committee (FOMC) is widely anticipated to announce a 25-basis-point rate cut at the conclusion of its meeting. This would continue a trend of lowering borrowing costs after a period of aggressive rate hikes aimed at taming inflation. While the immediate action seems straightforward, the context is far from simple. Inflation, while moderating, is still a concern. The labor market, though showing signs of softening, could still be a source of upward pressure on wages and subsequently inflation. The current range of the federal funds rate sits between 4.75% and 5.0%, and this cut would lower that range.
However, overshadowed by the immediate economic figures is Trump's unexpected election victory. During his previous term, he was a frequent critic of Fed Chair Jerome Powell and the Fed's policies, often advocating for lower interest rates. Now, with his return to the presidency, his proposed economic policies raise significant questions about the future path of monetary policy. Mr. Trump’s platform includes significant tax cuts, increased government spending, and the potential for renewed protectionist trade measures. Economists across the board are concerned that these proposals could potentially reignite inflation. While inflation remained low during his first term, this was despite similar economic policies being in place. These conflicting factors greatly complicate the task of the Fed.
"Everyone is on the lookout for future rate cuts and whether anything is telegraphed," commented Quincy Krosby, chief global strategist at LPL Financial. "Also, however, there's the question of whether or not they can declare victory on inflation." This highlights the central dilemma facing the Fed: balancing the need to stimulate economic growth with the risk of re-igniting inflationary pressures.
The upcoming post-meeting news conference by Chair Jerome Powell will be crucial. Analysts predict Powell, keeping to his historical preference of remaining detached from political influence, will likely avoid explicit comment on the implications of the election. "We think Powell will refuse to give any early judgment on the implications of the election for the economy and rates, and will seek to be a source of stability and calm," noted Krishna Guha, head of global policy and central bank strategy at Evercore ISI. Guha further added that Powell "will say the Fed will take the time it needs to study the new administration's plans" before making decisions.
Beyond the anticipated September rate cut, market participants are focused on the future. Market pricing currently points towards another quarter-point cut in December followed by a pause in January, with subsequent reductions projected throughout 2025. However, the uncertainty surrounding Trump’s economic agenda throws a shadow over these predictions. The possible consequences of Trump's intended policies are significant — potentially increasing the need for more forceful monetary policy tightening or potentially leading to decreased inflation. The Summary of Economic Projections (SEP), usually providing insights into future policy, will not be updated this time, delaying some answers until December.
A key question for the Fed, which wasn’t explicitly addressed during the September meeting, is the "terminal rate," or the point at which the central bank believes the rate-cutting cycle should end. "What we're going to hear more and more of is the terminal rate," explains Krosby. "That's going to come back into the lexicon if yields continue to climb higher, and it's not completely associated with growth." The current market speculation suggests that the Fed funds rate could reach a range of 3.75%-4.0% by the end of 2025, significantly lower than its current target.
The Fed's actions regarding its balance sheet represents another critical factor. Since the beginning of June 2022, the Fed been reducing the amount of Treasury bonds and mortgage-backed securities it holds. Reducing the bonds by nearly $2 trillion dollars has already been accomplished, however, this action is expected to conclude in early 2025. The interplay between rate cuts and balance sheet reduction adds yet another layer of complexity to the FOMC's decision-making process. “They’ve been happy to just kind of leave that percolating in the background and they probably continue to do that,” said Bill English, former head of monetary affairs at the Fed. “But there’s going to be a lot of interest over the next few meetings. At what point do they make a further adjustment to the pace of runoffs?” The balance sheet shrinkage could have ramifications for liquidity in the financial markets, influencing longer-term interest rates and lending conditions.
In conclusion, the Federal Reserve stands at a pivotal juncture. While a rate cut seems certain, the future path of monetary policy remains highly uncertain, due to the election and uncertainties surrounding the incoming administration’s economic plans. The coming months will test the Fed’s ability to manage complex economic data, political upheaval, and market expectations. The upcoming press conference from Chair Powell will be pivotal for investors, businesses, and policymakers alike. The signals the Fed sends will have a dramatic impact on future investment decisions and overall economic growth.
