Nick Timiraos, a prominent journalist known as the "Fed whisperer" (Wall Street Journal), published a second article this week, questioning whether the Fed would continue to cut rates in 2025 as the latest decision from the Fed is about to be announced. He stated that officials are trying to find a way to achieve "normal" rates during Trump's second term.
From the investors' perspective, a rate cut by the Fed this week is a foregone conclusion. However, within the Fed, the rationale for continuing to cut rates is less clear if the economy continues to grow.
Fed officials recently indicated that this week's rate cut may mark the end of the first phase of the "two-step rate cut" process. In the first phase, the threshold for rate cuts was relatively low as they previously maintained borrowing costs at such high levels. They also waited a few more months to gain confidence that inflation was closer to their target and was trending down.
Officials began a significant rate cut in September, with a reduction of 50 basis points. They cut rates again last month by 25 basis points. This week's cut will be the third consecutive rate cut.
Over the past year, officials have slowly raised their estimates for the direction of interest rates, and they may continue to do so in forecasts this week.
Some officials have begun to express that they need to see more concrete evidence before continuing to cut rates, indicating that inflation is improving or the labor market is weakening.
Cleveland Fed President Beth Hammack said earlier this month, "We are at or near the stage of slowing the pace of rate cuts." She praised two events from the 1990s when the Fed quickly cut rates by a total of 75 basis points and then moved to a wait-and-see approach.
The Fed's recent communications suggest that officials will adopt a more cautious tone regarding further rate cuts in the quarterly rate forecasts, and Fed Chairman Powell will also make such comments at the press conference.
Powell faces greater skepticism from colleagues who have been doubtful about rate cuts. The path of least resistance is to cut rates this week while providing guidance indicating that the Fed may not cut rates again until one or more meetings later.
Officials expected four rate cuts next year at the September meeting, but in the latest forecast, the number of cuts in 2025 may be reduced by one to two.
Approaching the neutral rate
This week's meeting may deepen the debate on two issues that could determine the direction of next year's rates: the position of the neutral rate and the likelihood of President-elect Trump's policy changes.
The so-called neutral rate is a Holy Grail; it neither stimulates nor slows economic activity. However, determining the position of the neutral rate is not straightforward, as economists have various estimates.
The closer the Fed gets to its estimate of the neutral rate, the weaker the justification for cutting rates becomes if inflation is stable and the labor market is not weak.
Currently, several officials suggest that the logic supporting last month's rate cut is likely to remain valid at least one more time.
Dean Maki, chief economist at hedge fund Point72 Asset Management, said, "The rationale for cutting rates is that they still believe they are some distance from the neutral rate, and... inflation does seem to be on a downward trend."
If the Fed does not cut rates as widely expected by investors, it may lead to more confusion about the Fed's actions and rationale. Recent developments in inflation and the labor market may not be enough to change officials' forecasts for the next one to two years, which is most relevant when considering where to set rates.
Furthermore, even with a 25 basis point cut, rates would still be above the most reasonable estimates of neutrality (about 2.5% to 4%). The Fed's federal funds benchmark rate is currently around 4.6%.
Former Fed Vice Chairman Donald Kohn said, "It appears that the Fed still has 50 to 75 basis points of room to cut rates."
However, some officials may oppose further rate cuts as they believe the economy does not warrant additional cuts, and that current rates are closer to neutral than most models indicate.
In the face of rapidly rising asset prices like stocks and Bitcoin, some officials may be concerned about continuing to lower rates as this could spur spending and hinder a further decline in inflation rates. "Are you going to pour gasoline on the fire? I don't know," Cohen said.
Those skeptical of rate cuts may become more convinced of their views, as the labor market has not been as weak as some feared at the end of summer. Inflation progress has recently stalled. Maki said, "The situation is not alarming, but inflation is not being suppressed as they hoped."
Many uncertainties
The trade, immigration, regulatory, and tax policy reforms proposed by Trump could reshape the growth, employment, and inflation outlook for the coming years. Officials will begin to address these changes at this week's meeting.
For example, deporting illegal immigrants and reversing lenient immigration policies could drive up wages but dampen demand. Tariffs could raise prices but might also squeeze profit margins, strengthen the dollar, or affect business sentiment. Any increase in energy production helps offset price increases in other areas. Cohen said in a recent interview, "Oh my gosh, there are so many moving parts here."
In light of these uncertainties, Powell stated that the Fed should not speculate about or take risks regarding the effects of these policies.
In a conversation earlier this month, Powell listed a range of unknowns regarding tariffs, including which products and countries would face tariffs, the scale of the tariffs, how much warning businesses would get, and how other countries would respond. He said, "We must go with the results."
Economists may present officials with potential impacts on the economy under various scenarios. "We are modeling... we are observing. But the decisions we make right now are unrelated to this," Powell said.
Several officials share the same view. Atlanta Fed President Bostic told reporters this month that he has asked his staff to "wait as long as possible" before incorporating assumptions about policy changes into the regional Fed's outlook for appropriate interest rate settings.
St. Louis Fed President Bullard said last month, "The December meeting is certainly too early to start incorporating potential policy changes into my personal views or forecasts."
However, some former officials said the Fed should incorporate potential changes in immigration and trade into its forecasts because these policy levers do not require congressional approval. Trump has threatened to impose tariffs and began deporting illegal immigrants from his first day in office.
Eric Rosengren, who served as Boston Fed President from 2007 to 2021, said, "Things won't happen until January 20 next year, yet you're making forecasts in mid-December. It's hard to say you won't overlook something."
Chicago Fed President Goolsbee agreed with this balanced approach. He told reporters this month, "I don't like making policy based on political speculation. That said, I also don't think we should just be reactive."
Article reposted from: Jin Shi Data