The Federal Open Market Committee reduced the federal funds rate by 25 basis points on Wednesday to a range between 4.5% and 4.75%.
Slowing inflation and strong productivity gains imply that the Fed has ample room to keep cutting rates next year.
Slowing inflation and strong productivity gains imply that the Fed has ample room to keep cutting rates next year.
The major takeaway from the policy statement is that the Fed believes that the risks to the employment and inflation sides of its dual mandate are in balance and that it is in no hurry to cut rates again next month.
Federal Reserve Chairman Jerome Powell noted in his news conference just how strong the American economy is, adding that it could be even stronger next year.
He also noted that as the Fed approaches levels that are “plausibly neutral or close to neutral, it may turn appropriate to slow the pace” of rate cuts.
With the bottom end of the current policy range only 100 basis points away from what we think is the likely neutral rate, conditions are coalescing for a pause.
While we would welcome an additional 25-basis-point rate cut, the economy is growing at a such a strong pace that the Federal Reserve seems likely to pause at its next meeting on Dec. 18.
We have forecast that the Fed will cut its federal funds policy rate by one percentage point next year to a rate at or near 3.5%. We expect one 25 basis-point cut in each quarter next year. This forecast is based on the economic status quo holding.
Read more of RSM’s insights on the economy and the middle market.
Because we are entering an era of unorthodox economic populism, that forecast could be affected by changes in both trade and immigration policies that could also affect employment, wages and, ultimately, inflation.
But given the proximity to the recent election and that the Fed has no involvement in fiscal policy, we do not expect any forward guidance from the Fed on what will be a different set of fiscal, trade and immigration policies. We will simply have to wait until any policy changes are made to update the forecast.
Should the economy continue to grow around 3%, the risk going forward is that the Fed’s policy will have a shallower path than the one currently implied by the 2.9% terminal rate embedded in the Fed’s September Summary of Economic Projections.
In addition, we think that the economy’s long-term rate of growth may now be higher than the Fed’s estimate of 1.8%, and as a result the Fed may need to boost its estimate of the terminal policy rate and the implied r-star, or the real neutral rate of interest.
In his news conference, Powell reiterated his confidence that the Fed is on a sustainable path back to a 2% inflation rate, which we expect in the near term. The Fed’s preferred measure of inflation, the personal consumption expenditures index, stands at 2.095%.
Powell declined to comment on fiscal policy.
In responding to a question on whether he would step down if asked by the incoming Trump administration, he simply said no.
The upcoming year in Federal Reserve policy will be interesting indeed.
