The Federal Reserve will announce its latest interest rate decision this week, and prior to that, a prominent journalist known as the 'Fed Whisperer' (Wall Street Journal) has written an article indicating that the Fed's rate cut plans are constantly changing, with investors widely expecting a third consecutive rate cut this week. After this, officials are prepared to slow or even stop rate cuts. Here are more details from the article.
When the Fed began to boldly cut rates by 50 basis points at the end of last summer, Chairman Powell had to assure some skeptical colleagues that the Fed would not inadvertently signal a crisis. Now, they are facing another potential turning point.
Officials cut rates by another 25 basis points in November, and investors widely expect a third consecutive rate cut this week. Powell is trying to find the right positioning amid signs of a less volatile labor market and inflation that appears slightly more robust than in September. Some officials have expressed doubts about continuing to cut rates, and those who previously strongly supported the first two cuts are no longer so certain.
One option this week is to cut rates by 25 basis points and then use new economic forecasts to strongly suggest that the central bank is ready to slow down rate cuts.
Jon Faust said, "At this point, both cutting rates and holding steady are reasonable options." He served as Powell's senior advisor from 2018 until early this year. He said officials' views on the trajectory of the Fed fund rate are likely "more important than any decisions made at the December meeting."
The Federal Reserve fund rate affects the borrowing costs throughout the economy, including mortgage, credit card, and auto loan rates. Increasing rates typically suppress hiring, spending, and investment, while lowering rates stimulates these activities. However, these effects can create what economists call long and variable lags, meaning the Fed may not know for a year or more whether their policies are too much or too little.
Have we gone too far or not far enough?
Some officials have indicated that they will oppose a rate cut this week. These hawks are concerned that the Fed may keep inflation rates far above target for the fourth or fifth year, thereby undermining the Fed's credibility.
Even if officials still believe that price growth will gradually slow to their target, some may lack confidence in this forecast due to President Trump’s promise to expel workers and impose tariffs after taking office next month. These measures could reverse the two developments that have supported officials' optimistic inflation forecasts: falling commodity prices and slowing wage growth.
Eric Rosengren, who served as president of the Boston Fed from 2007 to 2021, said: "If I were sitting on the committee now as a voting member, I would oppose the rate cut."
They are also concerned that the exuberance of speculative assets such as the stock market and Bitcoin could stimulate consumption, thereby prolonging inflation.
Fed Governor Bowman said in a speech this month, "Given the recent economic activity, it is currently hard to argue that the interest rate level is restrictive." Dallas Fed President Lorie Logan warned against overly cutting rates due to the mistaken belief that a more 'normal' rate is much lower.
Another group of officials, including Powell, indicated that they share the same concerns, but given that the Federal Reserve has raised rates to very high levels over the past two years, they believe there is currently no risk of excessively cutting rates.
Powell said last month, "We need to be mindful of the risks of going too far, too fast, as well as the risks of not going far enough. It seems we are where we need to be."
The labor market remains in a delicate balance. Hiring rates are low, but layoffs are also low. Over the six months ending in November, the economy added an average of more than 140,000 jobs, a significant figure. However, the unemployment rate has risen from 3.7% at the beginning of the year to 4.2%. Economic sectors most sensitive to high interest rates, such as housing, have yet to benefit from recent rate cuts.
Building a Car Behind Closed Doors
One of Powell's important tasks is to reach consensus among a sometimes inflexible committee of 18 other officials. This can be difficult, as inflation rates have fluctuated over the past year.
A year ago, after a series of relatively friendly inflation reports were released, some hawkish officials who had been reluctant to signal an end to interest rate hikes began to change their tune.
In the following months, Powell and his colleagues insisted that they needed a credible entry point to begin cutting rates. By Labor Day, Powell was increasingly anxious, fearing that after the central bank was shamed by inflation missteps in 2021, it would keep rates too high for too long.
Then, signs began to emerge that the labor market might be slowing more sharply than expected, with August data showing the unemployment rate rising to 4.3%. Inflation was returning to its earlier downward trend.
Federal Reserve officials typically prefer to orchestrate major moves without surprising the market. On September 6, the last day before officials began adhering to the traditional pre-meeting 'quiet period,' the comments of two officials led investors to believe they were more inclined to a smaller 25 basis point rate cut.
But Powell built a car behind closed doors and concluded with a smaller circle of advisors that they should start cutting rates with a larger 50 basis points. This idea borrowed from former Fed Chairman Alan Greenspan, who often persuaded colleagues by framing policy choices as managing different risks.
In this context, the risk of regretting larger rate cuts is considered very low. They have waited too long for rate cuts, so that even if the economy grows rapidly, most officials believe they can simply slow down the anticipated cuts. In contrast, if the cuts are smaller but the labor market is found to be sharply slowing, this would be a more difficult issue to address.
A lonely dissenter
Powell typically consults with all 12 regional Fed presidents on the Thursday and Friday before meetings and meets with six other regional Fed presidents based in Washington. Powell and his staff also distribute a series of briefing documents outlining the rationale for three different policy options.
Some people need little persuasion to launch into action. Others feel uneasy. In the past, cutting rates by 50 basis points often came with greater financial stress.
Bowman has been warning of the potential risks of more stubborn inflation, and when she saw these policy briefing materials, she knew she could not support Powell’s proposal. She ultimately voted against it at the September meeting, marking the first time since 2005 that a Fed governor has cast a dissenting vote.
To avoid multiple dissenters and win support from colleagues who shared Bowman’s reservations, Powell convinced them that he could frame the decision in subsequent public remarks as a strong adjustment rather than a panicked start to rate cuts.
Powell said at the post-meeting press conference, "There is nothing... indicating that the committee is eager to complete this work." Instead, he saw the rate cuts as a "good and strong start, demonstrating our determination not to fall behind."
Revisions to government data in the weeks following the meeting showed that income growth and personal savings rates were stronger than initially reported. This alleviated concerns about a potential economic recession and also suggested that the Fed might not need to take more aggressive actions.
Waller initially supported a smaller rate cut but was later persuaded to support a larger one, and he recently dismissed questions about whether he regretted that decision. He likened it to buying car insurance.
"You would ask, 'Why should I buy car insurance? Because I might have an accident,'" he said at an event this month. "If the accident does not happen, you would ask, 'Man, was buying car insurance a stupid decision?' Of course not."
Article reposted from: Jin Ten Data
