The easy part for the Federal Reserve on Wednesday will be announcing a widely expected interest rate cut at the end of its two-day policy meeting. The difficult part will be dealing with other details that pose significant challenges to policy-making these days.
The market has a nearly 100% chance that the Federal Open Market Committee will approve a 25 basis point cut in the federal funds rate for the second consecutive quarter. The benchmark for overnight loans is currently targeted at 4%-4.25%.
In addition, policymakers are likely to discuss future cuts, the challenges posed by a lack of economic data, and when to end cuts to the asset portfolio of U.S. Treasuries and mortgage-backed securities.
Underlying all these deliberations will be growing disagreement over what the future of monetary policy will be.
“We’re at a point in the policy cycle where there’s a real disagreement between those who think we’re probably going to cut rates, but not yet, and those who think it’s risky but now is the time to cut rates further,” said Bill English, a professor at Yale University and former Fed director. “There is a divide between people who want to cut back now and people who want to wait a little longer.”
Judging by recent statements and general sentiment on Wall Street, newly appointed Governor Stephen Milan is likely to oppose further rate cuts in favor of further rate cuts, as he did at the September FOMC meeting.
At the same time, local presidents Beth Hammack of Cleveland, Rory Logan of Dallas and Jeffrey Schmidt of St. Louis have expressed reluctance to push the cuts further, although it is unclear whether they will vote against the cuts this week. The only person who actually opposed last month’s 11-1 committee vote to cut the number by a quarter of a point was Mr. Millan, who wanted a half-point cut.
Left to bridge the gap is Chairman Jerome Powell, who in a recent speech expressed concern about the state of the labor market and implicitly agreed to cut interest rates in October.
Investors will look to the central bank governor, who retires in May 2026, for guidance on general sentiment.
Referring to the next policy meeting after this one, Mr. English said, “My hope is that he won’t necessarily back down in December, but will try to walk somewhere in the middle.” “I don’t think he wants to be locked into a rate cut in December, but at the same time he seems concerned about the outlook for the labor market and the real economy and doesn’t want to be seen as a hawk.”
According to CME Group’s FedWatch tool, the market is currently pricing in a rate cut in December as a near certainty, and it will be a long time before Wall Street stops expecting more Fed easing.
work worries
One of the main reasons why officials are in the mood to cut interest rates is concerns about the labor market. Despite the lack of data, there are clear signs that inflation is slowing, even if layoffs do not appear to be accelerating, judging by the filing of state-level unemployment claims that are still continuing despite the federal government shutdown.
In fact, concerns about jobs could cause the Fed to continue lowering rates through 2026, said Luke Tilley, chief economist at Wilmington Trust.
“We’re expecting 25 (Wednesday’s basis points) and then another rally in December and then again in January, March and April,” Tilley said. “That would bring it down to what we consider a neutral range of 2.75% to 3%.”
In September, Fed officials suggested that a so-called “neutral” rate, a rate that neither promotes nor suppresses growth, would not be reached until 2027, and even then it would be a quarter of a percentage point higher than Tilley’s forecast, after doing a “dot plot” of each member’s forecasts.
But he believes the Fed has no choice but to respond to labor market weakness, especially as it poses a challenge to the surprisingly strong economic growth seen in the second half of this year.
The Fed is focusing on concerns around jobs, even though inflation remains well above the central bank’s 2% target. The Bureau of Labor Statistics reported last week, in the only official release of data during the government shutdown, that annual inflation, as measured by the Consumer Price Index, remained at 3% in September.
Challenges of lack of data
Beyond the CPI report, central bankers face additional challenges from data blackouts associated with the government shutdown.
“It’s hard to develop policies to achieve those two goals … when you don’t have data on at least one of them,” Tilley said, citing the Fed’s dual mandate to maximize employment and keep prices stable, and the government shutdown that prevented the release of September’s nonfarm employment report.
“We hope to hear that there is more uncertainty about the path forward and that we need to be prepared to change and maintain policy rates if necessary, or be prepared to lower them more quickly once we finally have the data,” Tilley said.
Finally, the market will be looking for a more definitive answer on when the Fed will stop reducing its $6.6 trillion balance sheet, which is mostly in Treasuries and mortgage-backed securities. This process, known as quantitative tightening (QT), involves allowing the proceeds from maturing securities to be rolled off rather than being reinvested as usual.
Chairman Powell suggested in a recent speech that the time is near when the Fed wants to end QT. Financial conditions remain broadly strong, but there have been some small signs recently that short-term markets are tightening. With the Fed’s overnight funding line nearly depleted, officials are likely to signal this week that QT is in its final stages.
Market opinion was divided on whether the Fed would announce an actual end to the program or hint at a future end date.
“There are signs that we are nearing the bottom, so to speak, in terms of getting through the deep reserves and actually getting some tightness and liquidity. So I would expect announcements, if not action,” Tilley said.
