The Fed has waited four years to cut rates. But it’s still a tough call

Washington (CNN) — The Federal Reserve is widely expected to announce Wednesday that it is cutting interest rates, the first such move in more than four years.

Whether the central bank lowers borrowing costs by a supersized half point, as expected, or a more typical quarter point, the decision would mark a crucial turning point for the US economy — and for consumers battered by the highest costs in decades.

It’s also a sign of confidence from Fed officials that inflation has come under control just enough to comfortably dial back policy.

But it won’t be a declaration of victory over inflation, rather a careful balancing act that shifts more attention to America’s job market, which has shown signs of weakness.

Unusual amount of uncertainty

While the central bank has signaled in recent weeks that it is ready to lower borrowing costs, the call to cut rates by half a point grew louder in recent days. Typically, in the lead-up to a Fed policy decision, Wall Street and economists are in alignment on what to expect. But investors’ wagers for a half-point cut ramped up on Monday; and as of Tuesday afternoon, federal funds futures contracts were pricing in a 63% chance of a jumbo rate cut, up from around 30% on Thursday, according to the CME Group.

A number of prominent economists and lawmakers have also recently urged for a bold move this week. Fed Governor Christopher Waller, a key messenger for the central bank’s policy moves, said earlier this month: “The current batch of data no longer requires patience, it requires action.” On Monday, Senator Elizabeth Warren and two Democratic colleagues called for a three-quarter-point cut, saying the Fed’s “delay” was damaging the job market.

On Tuesday, former Dallas Fed President Robert Kaplan told CNBC in an interview that the Fed “may be a meeting or so late” and said he would advocate for a half-point cut. Former New York Fed President Bill Dudley said in an opinion article in Bloomberg that “the logic supporting a 50-basis-point cut is compelling.”

Still, the Fed has a track record of being prudent and making its decisions on interest rates consistent with what’s happening in the economy, and signs of economic bouyancy abound. New applications for unemployment benefits remain at historically low levels, American shoppers are still opening their wallets, the Dow and the S&P both touched new highs this week and, while it has increased, the unemployment rate remains low by historical standards.

“Despite Fed Chair Powell and Governor Waller’s openness to front-loading rate cuts, we anticipate ‘gradualism’ will prevail,” Gregory Daco, EY-Parthenon’s chief economist, said in a note last week. “We believe policymakers will form a consensus around a [quarter-point] rate cut.”

Keeping a close eye on America’s job market

For years, inflation has taken center stage, captivating the attention of Fed officials and investors. Not so much anymore.

That honor now goes to the Labor Department’s monthly employment report, which includes data on monthly payroll growth, wage gains and unemployment. As inflation skyrocketed in 2021 and 2022, American employers pumped out jobs and the unemployment rate declined to half-century lows. The Fed eventually responded to the country’s inflation problem with its bitter medicine of high interest rates.

The Fed has seen some welcome progress since kicking off its historic inflation-busting campaign in March 2022: The Fed’s favorite inflation gauge — the Personal Consumption Expenditures price index — registered an annual rate of 2.5% in July, down substantially from a four-decade high of 7.1% in June 2022. That’s within reach of the Fed’s official 2% target, and despite some stubbornness in elevated shelter costs, economists expect inflation to drift lower over the course of the year.

But since the Fed’s rate hikes function by cooling the economy and taking the steam out of inflation, they also likely played a role in pulling on the job market’s reins, which was always destined to move toward a more normal state from its post-pandemic heyday. Monthly job growth has weakened in recent months and the government announced the largest downward revision in its official jobs data since 2009, with 818,000 fewer jobs in the year ending in March than initially reported.

“We don’t see systemic employment concerns coming from large corporations yet, primarily because we have a resilient earnings environment, which doesn’t suggest massive looming layoffs,” Julia Hermann, global market strategist at New York Life Investments, told CNN.

“However, the other half of private employment in the US comes from small business, and they don’t think now is a good time to expand. So the overall effect is where we see cracks on the surface of the labor market.”

The-CNN-Wire
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