First, the bottom line
- The Fed’s move to cut its benchmark interest rate despite persistently elevated inflation and seemingly solid growth reaffirms their sensitivity to the potential for continuing degradation of labor market conditions, and their collective willingness to tolerate higher inflation to increasingly focus on the jobs market.
- Pending the release of the November jobs report, other recent data has provided some indications that labor markets, while soft, may be stabilizing. Even so, the data’s inconclusive, leaving sufficient ambiguity for the Fed to feel safer with another “insurance cut” to support labor conditions.
- The question is whether the current “curious balance” of the “no hire, no fire” labor economy can be sustained and, if not, in which direction conditions may break. It’s the risk of further slippage into outright job losses that has policymakers sufficiently concerned to cut by another quarter point today despite inflation remaining well above their 2% target.
Clearing the haze
- Despite Fed Chair Jay Powell’s efforts to tamp down expectations for a December rate cut at the Fed’s October meeting, market expectations coming into today were firmly in the camp of one more cut to close out the year.
- Policymakers delivered, trimming the central bank’s benchmark rate by a quarter point to end 2025 in a range of 3.5 – 3.75%. The Fed funds rate now stands at its lowest level since October 2022.
- Today’s decision to ease comes at a time in which there’s still a persistent murkiness to the economic picture as the backlog of delayed government economic data continues to clear.
- Labor market dynamics notwithstanding, the economy appears to still be growing at a solid clip — and perhaps even better than that. Further, the economy may be about to catch an additional consumer spending tailwind, benefitting from a fiscal boost of OBBB-related tax refunds in the months ahead.
- At the same time, consumer inflation (by virtually any measure) remains uncomfortably high, and has accelerated since April, with the imposition of various import tariffs playing an important role. Conversely, slower wage growth has helped to rein in service sector inflation — a dynamic that’s likely to continue given the softening in labor demand.
- The tug-of-war between price stability and full employment and the lack of clarity for the near-term path wasn’t lost on policymakers.
- Like beauty, the greater relative risk today appears to be in the eye of the beholder for policymakers. It’s clear that the respective proverbial eyes of individual FOMC members see those risks differently.
- The disparity in views between hawks and doves within the Fed is perhaps best illustrated by the unusually wide range of projections for the Fed funds rate over the next few years. The dot plot tells the tale: There may have been only two formal dissenters that preferred to hold rates steady today, but four additional FOMC participants submitted forecasts that called for rates to be left unchanged to end the year on hold.
- Further, the projected policy range over the next few years suggests that policymakers are unusually conflicted on how policy will need to be executed to meet their stated goals. If there’s an area that there appears to be widespread agreement, it’s that inflation isn’t returning to 2% in the near term, and rates will likely need to stay higher for longer, with the neutral rate likely sustainably higher than has been the case over most of the post-financial crisis period.
- At face value, the Fed’s updated projections suggest that one more cut next year may be in the cards, despite expectations for a marked year-on-year uptick in growth, fractional decline in unemployment, and inflation that’s expected to ease but remain well above the central bank’s 2% target.
- Will that ultimately be necessary? Can the Fed thread that needle without exacerbating inflation further? That remains to be seen, but the tension between the two aspects of the Fed’s mandate is real, as is the growing divide between the hawkish and dovish camps within the FOMC.
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