Fed Prepares Rate Cut Amid Economic Contradictions

Federal Reserve officials are expected to cut interest rates by a quarter percentage point at their meeting Thursday because inflation has continued to make progress toward their 2% goal.

Officials began lowering rates at their previous meeting in September by making a larger half-point cut. They are trying to figure out where, exactly, rates should settle after high inflation over the past three years led to a dramatic series of rate increases.

“We’re entering this new phase: Policy is going to become less restrictive over time, and that’s because the Fed is more confident on where inflation is going—that it’s going back down to 2%,” said Loretta Mester,

who retired as Cleveland Fed president in June after 10 years in the job. This week’s meeting should lack the suspense of the prior one, in which markets were left guessing over the size of the first rate cut in four years. Officials would like to avoid the spotlight because their meeting concludes two days after the presidential election, and the Fed strives to maintain an apolitical DNA.

Tuesday’s election also prompted the Fed to push back its meeting by a day. The central bank, which typically concludes its two-day meetings on Wednesdays, will do so this time on Thursday.

While this week’s meeting may lack drama, officials face potentially thorny debates in the months to come. First is the decision on where rates should settle. Second, while the election result won’t influence this week’s decision, any policy changes by the next president and Congress that reshape the economic outlook could also alter the Fed’s interest-rate path.

Strong consumption, softer hiring
Policymakers face a stubborn economic puzzle that could influence whether they will feel pressure to slow down or speed up rate cuts in the months ahead. The issue: The labor market continues to show signs of cooling, but consumer spending has been solid.

Economic data released last week put an exclamation point on this riddle. The economy grew at a solid 2.8% annualized rate in the July-to-September quarter, buoyed by consumer spending that has defied expectations of a slowdown for the past year. Some economists have pointed to such resilience as a sign that the Fed’s rate stance isn’t as tight as some officials think it is.

At the same time, demand for labor has steadily cooled. The private sector added just 67,000 jobs a month, on average, for the three months through October, the lowest since the pandemic hit in 2020. While the unemployment rate held steady at 4.1% last month, the share of workers who were permanently laid off ticked up to its highest level of the year, one of several signs pointing to less demand for workers.

It isn’t clear how long these trends—steady consumption with a slowing labor market—can last.

In one scenario, stronger consumer spending will continue to help stabilize the labor market because it will maintain solid demand for workers. In that more optimistic circumstance, the recent cooling in the labor market would reflect a postpandemic normalization and the Fed would be able to make fewer rate cuts.

More ominously, further weakness in income growth could weigh on consumer spending in the months to come, making the economy more vulnerable to a slowdown and potentially calling for more cuts.

A brighter income picture
Officials are also navigating through a fog of volatile data that has been revised from one month to the next. Several officials characterized the September rate cut as appropriate because inflation had fallen notably.

In the run-up to that meeting, the unemployment rate had ticked up to 4.3% in July and payroll growth had slowed. At the time, consumers had appeared to be spending down their savings to propel growth.

But revisions to government data after the meeting showed income growth had been stronger than initially reported. As a result, the personal savings rate was revised upward, meaning consumers might not be as tapped out. The revision “removes a downside risk to the economy,” Fed Chair Jerome Powell said at a conference on Sept. 30. “These were very large, healthy revisions.”

Powell suggested solid readings on economic activity could make officials somewhat more comfortable at the margins that the economy isn’t deteriorating. Still, he said labor-market data has historically provided “a better real-time picture” of the economy than data on gross domestic product. Solid activity data is “not going to stop us from looking very carefully at the labor-market data,” he said then.

‘Janky’ reports
Two whiplash labor-market reports have followed. Last month, the Labor Department reported that job growth had been stronger than expected in July and August, and payroll gains were exceptionally strong for September. That led to speculation that the Fed might need to consider slowing down the pace of future rate cuts.

Then last week, employment figures for August and September were revised lower. Moreover, payroll growth was much weaker than anticipated in October—some of it likely caused by strikes and hurricanes.

In the run-up to this week’s meeting, officials had cautioned against significantly rethinking their interest-rate outlook on the basis of any single monthly report. “I’ve been saying we should expect the data to be—what I’ve been using is, ‘janky,’ to bounce around a bit,” said Atlanta Fed President Raphael Bostic in an interview last month. “We may get ‘janky’ reports from time to time, and the question will be, ‘Do they signal a new trend?’”

Fed officials are likely to proceed with a quarter-point cut this week in part because they are trying to set policy based on their forecast that inflation will continue to decline. Inflation has slowed over the past year as prices of energy and goods have fallen. Many officials no longer see the labor market as a source of inflation because wage growth is cooling.

Officials often stress that their decisions are “data dependent,” meaning they will update their outlook for interest rates as their forecast for the economy changes. “‘Data dependence’…does not mean ‘data reactive,’” said San Francisco Fed President Mary Daly in an interview last month. “The jobs market data being revised and going back and forth is just a good lesson of why you can’t be data-point dependent.”

Bostic said the right approach in such an environment is to “remain patient and embrace the choppiness, if you will, in building a strategy and figuring out sort of where things should go.”