Fed rate cut: by a quarter point

(This story has been updated because an earlier version contained an inaccuracy and to add new information.)

After a significant reduction in the main interest rate half a percentage point in September, the Federal Reserve is expected to cut rates by a more moderate quarter point on Thursday and several times next year inflation continues to soften.

But if the Fed deviates from that steady pace, it will likely require a less sharp rate cut to ensure inflation continues to fall, economists say.

That could conflict with the view of some forecasters that the central bank has largely won the battle against rising prices and must cut interest rates quickly to “soft landing” that avoids one recession.

“The risks are probably more towards a pause (in December) rather than a half-point cut,” said Barclays economist Marc Giannoni. He thinks the most likely scenario is still a middle-of-the-road approach: a quarter-point rate cut this week and in December.

The stock marketHowever, yields have risen on the prospect of steady rate cuts and a pause could roil stock markets.

Republican Donald Trump’s election as president Tuesday is likely to lead to faster inflation because of his trade, immigration and tax policies, economists say, further raising the risk that the Fed will make fewer interest rate cuts.

How does an increase in interest rates affect inflation?

In 2022 and 2023, the Fed raised its benchmark interest rate to a 23-year high from 5.25% to 5.5% to quell a pandemic-induced inflation spike, before raising rates for the first time in four years in September reduced.

The Fed raises interest rates to discourage lending and economic activity to curb inflation. It lowers rates to stimulate weak job growth and a stagnant economy.

What slows down an economy?

After a two-day meeting concludes Thursday, economists do not expect Fed Chairman Jerome Powell to signal when or how quickly the Fed will cut rates. Instead, they say its actions will depend on how the economy and inflation develop. A market sell-off that negatively impacts consumer spending, a spike in bankruptcies among struggling small businesses or concerns about federal policy changes after the election could all throw the labor market into turmoil, economists say.

Last week’s gloomy week The October jobs report at the very least raised the question of whether the central bank should cut interest rates again by half a point this week to counteract a labor market that could lose momentum faster than expected.

Although two hurricanes in the Southeast and a Boeing employee strike were expected to hit payrolls, the 12,000 jobs added last month were far fewer than the expected 105,000. And job growth for August and September was revised down by as much as 112,000 jobs.

In one letter Speaking to Powell on Friday, Senators Elizabeth Warren, D-Mass., and John Hickenlooper, D-Colo., urged Fed officials to cut rates by half a point on Thursday.

“Even if the economy remains strong, demand for workers could decline as a result of the Fed’s restrictive monetary policy,” they wrote, citing a rising number of Americans collecting unemployment benefits.

But Giannoni and other economists said it is a challenge for Fed officials to assess the extent to which the storms and strikes have curtailed employment. As a result, he said they would likely write off the poor performance to the one-off events.

What is the current state of the labor market?

Even after the major downward revisions to wage increases over the past two months, Giannoni noted that job growth from July through September averaged a solid 148,000. That’s down from the average monthly additions of 267,000 in the first three months of the year. But job creation is expected to decline due to catch-up effects related to the pandemic and the Fed’s historic rate hikes to combat inflation.

“The economy is stuck,” said Ryan Sweet, chief U.S. economist at Oxford Economics.

The unemployment rate – which reflects whether workers have a job and not whether they started work in a given week – remained stable at 4.1% last month. That means unemployment will likely end the year below the 4.4% the Fed forecast in September, underscoring that the labor market is still on solid footing.

And a report last week showed the economy grew at a healthy 2.8% annual rate in the third quarter, thanks to a robust 3.7% increase in consumer spending.

Will inflation decrease in 2024?

Inflation is now falling, but not as quickly as estimated. The Fed’s favorite annual inflation measure fell to 2.1% last month, just above its 2% target. But a core inflation measure that excludes volatile food and energy products — which the Fed is watching more closely — remained steady at 2.7% and is likely to end the year above the 2.6% forecast by Fed officials.

The costs of services such as health care and auto repairs continued to rise, partly due to steep wage increases for workers that companies pass on to consumers.

The upshot: The Fed may still have to worry more about a resurgence in inflation than a sputtering labor market. “There is no guarantee that inflation will return to 2%,” Giannoni said.

How does immigration affect inflation?

The past few years have been a immigration wave expanded the labor force and dampened wage growth, but that is slowing after the White House restricted crossings at the southern border in June. Barclays estimates that core inflation will reach 2.3% in 2025, still above the Fed’s 2% target.

How will the 2024 election impact the economy and Fed rate cuts?

Trump’s victory is expected to further limit immigrants’ contribution to the labor supply as he has proposed deporting millions of immigrants who lack permanent legal status, according to Moody’s Analytics. He has also proposed imposing a 10% tariff on all imports and a levy of as much as 60% on Chinese imports. And Trump – especially if there is a Republican majority Congress – is likely to extend the 2017 tax cuts, further stimulating economic growth.

Tighter immigration, higher rates and a hotter economy are all expected to lead to stronger inflation in the near term. Nomura, a research firm, now expects just one rate cut next year. Oxford Economics believes that Trump’s policies will not take effect until 2026 and expects the Fed to cut rates until then.

Pantheon Macroeconomics thinks Trump’s tariffs and immigration restrictions will ultimately hurt economic growth, forcing the Fed to cut rates even more sharply.

For now, Nomura expects the Fed to cut its policy rate to a range of 3.5% to 3.75%, above the 2.75% to 3% that Fed officials had forecast in September.

Goldman Sachs economist David Mericle does not think officials will suspend their interest rate cuts in December. The Fed wants to ensure that a labor market that has been shaky lately stabilizes, he wrote in a letter to clients. He also noted that some Fed officials have said that high interest rates have “a constraining effect” on the economy and that lowering them too slowly “could weaken economic activity and employment too much.”

But while he expects the Fed to cut rates to a range of 3.25% to 3.5% at four consecutive meetings in the first half of 2025, he added that a robust labor market would instead prompt officials can encourage interest rates to decrease every other meeting.

“The risk is that they will make fewer interest rate cuts next year,” Sweet said.