The Federal Reserve has postponed interest rate reductions for a period of four years. However, deciding on this action remains challenging.
If the Federal Reserve decides to decrease borrowing costs by half a percentage point, as many expect, or by a more traditional quarter point, this choice would represent a significant turning point for the American economy and its consumers, who have been struggling with record-high costs lately.
This move would also indicate that Federal Reserve officials have gained enough confidence that inflation is under control enough to allow for a relaxed policy adjustment. However, it won't signify a complete triumph over inflation but rather a delicate balancing act that shifts focus to America's job market, which has shown signs of vulnerability.
There's been an unusual level of uncertainty lately regarding the central bank's decision to lower interest rates. While the Federal Reserve has been hinting at reducing borrowing costs, calls for a half-point cut have grown louder in recent days. Typically, before a Fed policy decision, financial markets and economists are in agreement about what's expected. However, investor bets for a half-point decrease surged on Monday; by Tuesday afternoon, federal funds futures contracts indicated a 63% likelihood of a substantial rate cut, up from around 30% on Thursday, as per CME Group.
A number of prominent economists and lawmakers have also advocated for a bold move this week. For instance, Fed Governor Christopher Waller emphasized the need for action earlier this month, stating that the current data no longer warranted patience. Senator Elizabeth Warren and her Democratic colleagues even urged for a three-quarter-point cut, claiming that the Fed's delay was damaging the job market.
On Tuesday, former Dallas Fed President Robert Kaplan advised CNBC in an interview that the Fed might be slightly behind schedule and advocated for a half-point cut. Meanwhile, former New York Fed President Bill Dudley argued in a Bloomberg opinion piece that "the logic supporting a 50-basis-point cut is compelling."
Despite Fed Chair Powell and Governor Waller's openness to early rate cuts, economist Gregory Daco predicted "gradualism" would prevail in a note last week. He suggested that policymakers would reach a consensus for a quarter-point rate decrease.
Closely monitoring America’s job market
For a long time, inflation has held the spotlight, grabbing the attention of Federal Reserve officials and investors alike. No longer, though.
Now, the focus has shifted to the Labor Department's monthly employment report, which includes information about monthly payroll growth, wage increases, and employment rates. As inflation soared in 2021 and 2022, American employers continued to create jobs, and unemployment rates slipped to near half-century lows. Ultimately, the Federal Reserve tackled the country's inflation issue by administering its harsh remedy of high interest rates.
Since initiating its inflation-busting campaign in March 2022, the Federal Reserve has seen some progress: The Fed's preferred inflation gauge, the Personal Consumption Expenditures price index, showed an annual rate of 2.5% in July, a significant decrease from the four-decade high of 7.1% in June 2022. This figure draws near to the Fed's official 2% target, and despite some lingering increases in housing costs, economists anticipate inflation will continue to decline throughout the year.
However, since the Federal Reserve's interest rate hikes have a cooling effect on the economy and help reduce inflation, they may also have weakened the job market, which was naturally headed toward a more normalized state post-pandemic. Monthly job growth has slowed in recent months, and the government released the largest downward revision in its official job data since 2009, reporting 818,000 fewer jobs in the year ending in March than initially reported.
“Despite Chair Powell and Governor Waller’s readiness for 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 reach a consensus around a [quarter-point] rate cut.”
This potential interest rate decrease by the Federal Reserve could significantly boost businesses in the American economy, providing them with cheaper borrowing costs. The improvement in the business environment could also lead to increased consumer spending, further aiding the economy.
The decision on the interest rate cut will have implications for various sectors of the economy, with businesses in particular watching closely to assess how lower borrowing costs might affect their operations and profitability.
