Jerome Powell, chair of the Federal Reserve, faces a crucial moment as the central bank prepares for its next policy meeting. The latest jobs report all but solidified expectations of an interest rate cut later this month, with market indicators assigning a nearly 90% chance to such a move. However, whether the Fed should proceed with the cut and how it will manage monetary policy afterward remain open questions, sparking heated debate among economists and politicians.
November's jobs data presented a balanced picture, neither overly strong nor overly weak, giving the Fed the flexibility to justify a rate cut. Nonfarm employment increased by 227,000, a significant improvement over the 36,000 jobs affected by the October hurricane and strike. That's about 131,500 new jobs on average over the past two months, slightly lower than the trend seen earlier this year. Despite this, the labor market remains resilient, with unemployment rising to 4.2% and household employment contracting slightly.
While this data appears to support a rate cut, not everyone agrees that it is the right move. Critics warn of potential risks, such as fueling speculative bubbles in financial markets or undermining the Fed's credibility in its fight against inflation. Joseph LaVorgna, chief economist at SMBC Nikko Securities, argued that financial conditions have eased significantly in recent months and warned against cutting rates too soon. “There is no reason to cut rates right now. They should take a break,” LaVorgna said, underlining the risk of creating instability in financial markets.
Similarly, Chris Rupkey, senior economist at FWDBONDS, questioned the need for further rate cuts, especially given the robust labor market. Rupkey stressed that the Fed's decision to continue the easing cycle could be perceived as premature, especially as inflation remains above target. Jason Furman, a former White House economist under Barack Obama, echoed these concerns, pointing out that wage growth – currently at 4% – is consistent with an inflation rate of 3.5%, well above the Fed's 2% target.
“This is another no-landing scenario,” Furman noted, referring to an economic environment in which growth persists despite increased inflation risks. He added: “I have no doubt the Fed will cut again, but the timing of future cuts beyond December is uncertain. It will likely take more than a moderate increase in unemployment to spur further action.”
Weigh the factors
The Fed's decision is further complicated by other economic indicators. Inflation, as measured by the Fed's preferred gauge, rose to 2.3% in October, or 2.8% excluding volatile food and energy prices. This marks a slight upside, signaling that inflationary pressures have not fully abated. Wage growth also remains elevated compared to pre-pandemic levels, further complicating the Fed's calculations.
Adding the overall strength of the economy to the equation. The Atlanta Fed estimates the fourth quarter will see an annualized GDP growth rate of 3.3%, underscoring the resilience of the U.S. economy. Financial conditions, which include metrics such as bond yields, stock prices and mortgage rates, have eased to levels not seen since the start of 2023, even as the Fed keeps its policy rate in a “narrow” range of 4, 5% and 4.75%.
Fed Chair Jerome Powell has acknowledged these dynamics, recently describing the U.S. economy as “the envy of the developed world.” His remarks suggest the central bank has room to proceed cautiously in recalibrating monetary policy. However, not all Fed officials share the same level of optimism.
Cleveland Fed President Beth Hammack, for example, has advocated a more measured approach to rate cuts. Speaking on Friday, Hammack highlighted strong economic growth but stressed the need for more evidence that inflation is moving decisively toward the Fed's 2% target. “To balance the need to maintain a moderately restrictive stance on monetary policy with the possibility that politics is not far from being neutral, I believe we are at the point, or close to it, where it makes sense to slow the pace of rate cuts. “, he said.
The question of neutrality
The concept of a “neutral” interest rate – a rate that neither stimulates nor constrains economic growth – is central to the Fed's current policy debate. Recent indications suggest that this neutral level may be higher than in previous economic cycles, further complicating the Fed's decision-making process.
The Fed's next steps could involve implementing the December rate cut, a pause in January, and a potential rate cut in early 2025. Tom Porcelli, chief U.S. economist at PFIM Fixed Income, believes this is a scenario likely. “I don't think there's anything in today's data that would actually stop them from cutting in December,” Porcelli said. He argued that the Fed's aggressive rate hikes in 2022 were designed for a very different inflationary environment than the one currently in place. “In this context, Powell would like to continue the process of normalization of politics,” he added.
Powell and other Fed officials acknowledged a shift in focus. While controlling inflation remains a priority, greater emphasis is now being placed on supporting the labor market and avoiding unnecessary disruptions to economic growth. Porcelli cautioned against waiting too long to adjust policy, stressing that delaying rate cuts until the labor market shows significant cracks could be too late. “Prudence would really dictate starting this process now,” he said.
What awaits us
One potential obstacle to the December rate cut is the release of inflation data, expected next week, including reports on consumer and producer prices. The consumer price index (CPI) is expected to show a 2.7% increase, which could influence Fed decisions. After Friday, Fed officials will enter a “quiet period,” refraining from comments public until after the political meeting.
The broader question for the Fed is how to navigate the fine line between easing monetary policy to support growth and maintaining credibility in its inflation-fighting mandate. Recent data suggests the central bank may be close to the point where policy becomes neutral, but the exact timing and size of future rate cuts remains uncertain.
In the coming weeks, Powell and his colleagues will weigh these competing factors in what could be one of the most important decisions of the year. The outcome will not only determine monetary policy in the near term, but also set the tone for how the Fed will approach its dual mandate of price stability and full employment in a post-pandemic economy.
As the December meeting approaches, the Fed faces a delicate balancing act. With an economy showing resilience but persistent inflationary pressures, the central bank must carefully calibrate its actions to avoid excessive corrections. Whether this will result in a decisive shift or a more cautious approach remains to be seen, but one thing is clear: Decisions made in the coming weeks will have far-reaching implications for the U.S. economy and beyond.