It looks like everything is fine at the Federal Reserve.
Economists think that Fed Chair Jerome Powell and his colleagues will mostly agree on a decision next Thursday to lower the benchmark interest rate by a quarter percentage point, to a range of 4.5% to 4.75%. This comes after the first cut of half a point in September.
It’s unlikely that the policy statement that came out with the result will change much. The Fed wants to slowly lower interest rates because they believe that monetary policy is too tight.
But economists say that deep down, there will be heated arguments and differences about how to move interest rates forward.
“There will be a lot to talk about behind the scenes,” said Ryan Sweet, top U.S. economist at Oxford Economics.
Chief economist at Stifel Financial Lindsey Piegza, on the other hand, thinks the Fed is less united than most people think.
Piegza said that some officials are worried about inflation that is still high and don’t want rates to go down too quickly. The other group is more afraid that the job market might be weakening too much, which would mean that more cuts, possibly big ones, are needed.
In an interview, Piegza said, “It’s almost as if you have this very clear bifurcated Fed at this point, split across the dual mandate.”
Congress has given the Federal Reserve two goals: one is to keep inflation low, and the other is to make sure the job market is strong and healthy. This is called the “dual mandate.” The two don’t always agree. Rate cuts would be good for the economy and the job market, but they could cause inflation to rise again.
Things are already hard enough, and the outlook for the business isn’t clear. There are some things that the Fed doesn’t know yet.
In a note to clients, Dario Perkins, managing director of global macro at TS Lombard in London, said, “The current situation is just weird. We have never had the Fed raise rates 200 basis points above its estimate of [a neutral level of a funds rate] only to see inflation go away without a recession.”
The central bankers will have a lot to talk about at their meeting next Wednesday and Thursday. Thursday at 2 p.m. ET, the Fed will put out its policy statement. His press meeting will begin at 2:30 p.m.
Take a quick look at some of the big problems that the Fed is facing.
The back-up in 10-year yields
When the Fed cut rates by an aggressive half percentage point in September, the bond market didn’t react by easing financial conditions.
Instead, the 10-year yield has jumped 73.9 basis points from its 52-week low of 3.62% reached on Sept. 16.
Piegza said the bond market was signaling the Fed decision to cut by a half-point in September was a “overreaction” and a quarter-point would have been wiser.
Fed officials will get a report from their staff experts about financial market conditions and the 10-year yield.
The Fed officials who are worried about inflation won’t mind that the 10-year yield has moved higher because it can tighten financial conditions and dampen price pressures.
But Fed officials concerned about the health of the labor market and the economy won’t be so relaxed. They will see the 10-year move as damaging the economy mainly through the housing sector.
“The housing market has been taking it on the chin from higher interest rates. Mortgage brokers were just trying to survive until the Fed cut rates, but long-term rates have moved up when the Fed started lowering rates,” said Sweet of Oxford.
Gregory Daco, chief economist at EY-Parthenon, said Fed officials will want to get a better handle on what’s driving yields and whether there is a need for monetary policy to respond.
The back-up in 10-year yields
When the Fed cut rates by an aggressive half percentage point in September, the bond market didn’t react by easing financial conditions.
Instead, the 10-year yield has jumped 73.9 basis points from its 52-week low of 3.62% reached on Sept. 16.
Piegza said the bond market was signaling the Fed decision to cut by a half-point in September was a “overreaction” and a quarter-point would have been wiser.
Fed officials will get a report from their staff experts about financial market conditions and the 10-year yield.
The Fed officials who are worried about inflation won’t mind that the 10-year yield has moved higher because it can tighten financial conditions and dampen price pressures.
But Fed officials concerned about the health of the labor market and the economy won’t be so relaxed. They will see the 10-year move as damaging the economy mainly through the housing sector.
“The housing market has been taking it on the chin from higher interest rates. Mortgage brokers were just trying to survive until the Fed cut rates, but long-term rates have moved up when the Fed started lowering rates,” said Sweet of Oxford.
Gregory Daco, chief economist at EY-Parthenon, said Fed officials will want to get a better handle on what’s driving yields and whether there is a need for monetary policy to respond.
The final destination for rate cuts?
Fed officials want to cut rates gradually but there is no agreement on where to stop or even to pause.
The Fed wants to get its benchmark rate to a “neutral” level that neither spurs or weakens demand.
Fed officials don’t agree on what the neutral rate is. They publish their estimates every quarter but the dispersion of estimate from Fed officials runs from a little above 2.0% to almost 4%.
“I think you have a lively debate about where that neutral rate is,” Sweet said. He said the issue has been a central topic of Fed officials for months.
“They don’t know where the destination is and how quickly they want to get there,” Sweet said.
Some Wall Street economists even bristle at the notion of a neutral interest rate, which is always just an estimate.
Publishing a neutral rate ”obscures more than it illuminates” because it changes all the time based on economic circumstances, said Lou Crandall, chief economist at Wrightson ICAP.
Election uncertainty
Fed officials may have a sense of who the next U.S. president will likely be when they meet Thursday.
While the the presidential election won’t factor into their immediate decision, the next administration’s tax, trade, and immigration policies, will play a big role in the economy in coming years.
Import tariffs and other policies may have economic and inflationary impacts, said Michael Gregory, deputy chief economist at BMO Capital Markets, in a note to clients.
“Depending on the economic or inflation impacts, the Fed might need to adjust its policy stance accordingly,” he said.
Sweet of Oxford Economics said he doesn’t think the economy will be impacted by presidential decisions until late 2025 or early 2026 no matter who wins the White House.
“It is likely to be too early for Powell to comment on the monetary policy implications of the U.S. election,” said Andrew Husby, senior economist, U.S., for BNP Paribas.
Some form of forward guidance
Fed officials have said they will be data-dependent in deciding the pace and size of rate cuts.
This has led the market to focus even more intently on recent data. This trend has been going on all year. Some economists estimate that bond-market moves in the U.S. have been twice as large on days of major releases or Fed decisions as on other days. Stock market moves have been two-thirds larger.
The International Monetary Fund recently said that volatility would be reduced if the Fed would clearly communicate that its policy path would not be altered by any individual data point.
Daco agreed, saying he thought the Fed should propose a more forward-looking narrative. “The time for data dependence has passed,” Daco said. The Fed should be forecasting the next three, six and 12 months, he said, even though this runs right into election uncertainty.
Perkins of TS Lombard doesn’t see an alternative to data dependency.
“The reality is that officials can’t tell us precisely what they are going to do —because they are just as confused as the average investor. Like most, they have been whipsawed several times by this weird ‘cycle’,” he said.
