cryptopolitan.com
Federal Reserve officials are heading into their policy meeting on Tuesday with a lot of optimism, and some uncertainty too.
Inflation is finally cooling off, edging closer to their 2% target. But the big question remains:- How much will they ease up on interest rates?
Recent data shows price pressures have eased so much since the wild surge in 2021-22. 12-month consumer inflation is at its lowest since February 2021.
Wholesale prices are also under control, suggesting that upstream costs aren’t pushing inflation anymore. So, what’s the holdup at the Fed?
The debate intensifies
With inflation numbers looking friendlier, the path seems clear for an interest rate cut at the Federal Open Market Committee meeting, which wraps up on Wednesday.
“We got two more months of good inflation data since the last Fed meeting. That’s what the Fed asked for,” said Claudia Sahm, chief economist for New Century Advisors.
But financial markets are about as decisive as a squirrel in traffic. Futures markets spent most of last week betting on a 25 basis point cut.
Then traders flipped the script on Friday, showing an almost even chance between a 25 or 50 basis point reduction, according to the FedWatch tool.
Sahm is all for a bigger cut. She thinks that the inflation data alone justifies a 25 basis point cut next week and a series of cuts afterward.
“The federal funds rate has been over 5%, has been there for over a year to fight inflation. That fight is won. They need to start getting out of the way,” she stated.
She suggests kicking things off with a 50 basis point cut to prevent potential decay in the labor market.
Inflation is not cold yet
The battle against inflation isn’t over, but we’re finally making headway. The all-items Consumer Price Index (CPI) inched up just 0.2% in August, bringing the annual rate to 2.5%.
Strip out food and energy, and core inflation stands at 3.2%. Not exactly hitting the bullseye, but at least we’re on the dartboard.
A big chunk of the stubborn core inflation comes from high shelter costs. The Bureau of Labor Statistics uses an “owners equivalent rent” measure, which rose 5.4% from a year ago and makes up about 27% of the total CPI.
It’s a quirky metric that asks homeowners what they could get if they rented out their place. Despite these sticky areas, consumer confidence is growing.
A University of Michigan survey in September found that people expect inflation to run at 2.7% over the next year—the lowest since December 2020.
Yes, Jerome Powell said that his “confidence has grown” in inflation trending back to 2%. But he also mentioned that the Fed does “not seek or welcome further cooling in labor market conditions.” Sahm said:
“If Powell wants to deliver on his ‘we want no further weakening, no further cooling,’ they are going to have to really move here because that cooling trend is well established. Until it is interrupted, we will continue to see payrolls drift down and unemployment rate drift up.”
The case for a smaller cut
Not everyone is shouting “Go big or go home!” There’s a camp that believes the Fed should stick to a modest quarter-point cut. Tom Simons, an economist at Jefferies, told us that:
“That’s really the key they need to hone in on—that they are normalizing policy and not trying to provide accommodation for an economy that is really in trouble. I think they’ve done a very good job of expressing that point of view so far.”
Even with a quarter-point move, the Fed has room to breathe later. Market pricing shows that rates could drop by 1.25 percentage points by the end of year.
“They’ve been cautious about cutting because they’re concerned that inflation is going to come back,” Simons explained. “Now, they have more confidence based on data that suggests inflation isn’t coming back right now. But they need to be very careful to monitor potentially changing dynamics.”
Economists predict a soft landing
Good news, folks: The U.S. might just pull off a soft landing. Economists polled by the Financial Times predict the economy will expand while inflation drifts back to the Fed’s 2% target.
Gross Domestic Product (GDP) growth is expected to be 2.3% in 2024 and 2% in 2025, according to the FT-Chicago Booth survey.
“It’s a shockingly smooth landing,” said Dean Croushore, a former economist at the Fed’s Philadelphia Reserve Bank who participated in the survey. “Fundamentally, things are still pretty strong across the board.”
The survey also found that most respondents don’t expect a contraction in the next few years.
Now, let’s throw a political wrench into the economic gears. The September meeting comes just seven weeks before Donald Trump and Kamala Harris square off in the polls.
Both candidates have starkly different economic platforms.
While Trump is pushing for tariffs, corporate tax breaks, and deregulation, Kamala is focusing on tackling price-gouging and raising taxes on the wealthy and big businesses to fund more generous social safety benefits.
When economists were asked whose economic platform would be more inflationary, 70% picked Trump’s. The same percentage thought his plan would lead to larger deficits.
Less than a third saw no material difference in terms of inflation, and roughly a fifth said the same regarding the deficit.
The so-called Sahm Rule, which marks the start of a recession when the three-month average unemployment rate rises at least half a percentage point above its low over the past 12 months, might not apply this time.
More than 90% of the economists believe the Fed will go for the quarter-point cut. About 40% expect the policy rate to fall by three-quarters of a percentage point or more this year.
By the end of 2025, over 80% think it will be at 3% or more. So here we are, stuck in limbo, waiting to see what the Fed will do next. Will they go big, or play it safe?