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PratapDarpan > Blog > Buisness > Market Insight > The Fed faces an important choice after these cuts
Market Insight

The Fed faces an important choice after these cuts

PratapDarpan
Last updated: 17 December 2024 06:36
PratapDarpan
6 months ago
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The Fed faces an important choice after these cuts
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There is broad agreement in markets and among economists that the Federal Reserve will cut interest rates at its policy meeting on Wednesday. This is also in agreement with forward guidance suggesting lower cuts in 2025 than previously indicated, higher terminal rates and a break in January. In addition, much will depend on the evolution of the Fed’s thinking about the inflation rate, which is proving stickier than its 2% target.

The market is pricing in a more than 90% probability of a 0.25-percentage-point cut in the Fed funds rate this week. Officials are likely to pencil in a higher “dot plot” for rates, with a terminal rate hike closer to market expectations, despite the scatter in forecasts between them. Finally, while Chair Jerome Powell won’t completely close out his options for January, he is expected to signal in his press conference that the central bank will be patient when the Federal Open Market Committee meets next month.

What comes after January is a subject of interesting debate. Many expect easing to resume after the “leave,” with cuts continuing on a quarterly basis through 2025. Some consider it more of a “pause,” which then assigns more uncertainty to rate cuts. Few, at least for now, look as if Wednesday’s decline could mark the end of the current cutting cycle.

Differing assessments of inflation, the economy, and the policy intentions of the incoming administration explain this range of views. The fact that the Fed’s path to easing in 2024 has diverged by about 75 basis points from the consensus in markets a year ago is also playing a role.

Last week’s inflation data confirmed the now more hesitant nature of the Fed’s journey back to the 2% target, something few of us have noticed for a while. Excluding volatile food and energy costs, consumer prices rose 0.3% for the fourth straight month, a report released last Wednesday showed. The next day’s producer price index report was slightly warmer than expected. The components of both do not translate comfortably to a faster 2% for the Fed’s preferred inflation gauge.

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    In such a world, the Fed will soon be forced to face an important policy choice, with implications for US economic exceptionalism and the health of the stock market.

    Should it clearly and unambiguously reaffirm its 2% inflation target and redouble efforts to get the economy there? Powell said last month that “we don’t speculate, we don’t speculate, and we don’t assume” when it comes to the incoming administration’s policies. Holding the current target still involves the Fed delivering a starkly “hawkish cut” on Wednesday. Behind closed doors, thinking on future cuts has ranged from “we can continue to cut rates because it’s only a matter of time until inflation reaches our target” to “we need to keep policy reins for a while. Longer than we think.” ” Indeed, under such circumstances, a U-turn involving a rate hike is not entirely out of the question.

    Else, should it be implicitly accepted that with all the structural changes going on domestically and internationally, the equilibrium inflation rate of the economy has gone up? Put another way, the economy can run at an inflation rate close to 3% and hence, without damaging growth prospects, without deflating expectations. If that’s true, the Fed tries to push the economy toward a world with strict 2% inflation, further risks to US economic exceptionalism, stock markets and financial stability.

    To be clear, this is not the second scenario in which the Fed publicly abandons the inflation target for a new range of 2.5%-3%. That won’t happen given how much he’s missed over the last three years. Instead, in its public comments, the Fed will push back the date for achieving the current target. Behind closed doors, policy will be run with realistically lofty goals for now.

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