We expect a contentious meeting of the Federal Open Market Committee on Dec. 9-10 in which the committee will cut its policy rate by 25 basis points to a range between 3.5% and 3.75% amid a strong dissent over the risk of inflation.
On one side will be the one or more members who will oppose any rate cuts, while the other will have Governor Stephen Miran pushing for a 50-basis point rate cut. And the debate will only continue as members make their case publicly in the days and weeks to come.
As for Federal Reserve Chair Jerome Powell, he is likely to lean in a hawkish direction in his post-meeting remarks, which the market will interpret as lifting the bar for a January rate cut in January.
As is often the case when Powell adopts a hawkish view, one should anticipate volatility in asset prices with possible declines in equity prices as he lays out the risks to the economy.
While a soft labor market will be the justification for the rate cut, the hawks, in pushing for a pause, will point to a lack of economic data from the government shutdown, and a sustained demand for services that is keeping inflation elevated despite disinflation elsewhere.
The most recent public inflation data, for example, was the personal consumption expenditures index, which was released on Friday after an extended delay. Both the core and top-line personal consumption expenditures index, the Federal Reserve’s preferred inflation gauge, advanced at 2.8% annualized pace, with service-sector inflation remaining sticky.
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For this reason, conditions are ripe for a hawkish cut in which investors will not be presented with a holiday gift or another likely near-term cut.
While we expect another one or two rate reductions next year, none of the four models that we run estimating the Fed’s optimal policy rate suggests that a rate cut is appropriate.
Whatever decisions the Fed makes, the path forward is fraught with risk should inflation remain sticky or rise even as monthly job creation remains soft.
The dot plot
Because of the factions that have formed on the FOMC, we do not expect any material change to the FOMC’s interest rate forecast, or dot plot. The median dot is likely to remain unchanged at 3.375% which implies at best one more rate cut next year.
Now, because the Fed next year will be getting a new chair who is likely to have a dovish bias, the new dot plot will represent the start of the great game in which the new chair could easily be outvoted should inflation remain sticky and stubborn.
Because the Summary of Economic Projections will surely feature an increase in the estimate of the unemployment rate, risk is skewed in favor a modestly lower median dot.
Summary of Economic Projections
We anticipate that the Summary of Economic Projections will feature a modest increase in the unemployment rate and inflation for this year while the forecast for next year should feature an improvement in gross domestic product and an increase in the unemployment rate. The forecast for inflation next year will reside where the 2025 forecast lands.
The committee’s estimate on both the top-line and core measures of the personal consumption expenditures index, the Fed’s preferred measure of inflation, will not show pricing moving back to the 2% target until next year.
We do not expect the Fed to update its plans for the end to quantitative tightening or reserve management purchases at this meeting; any announcement on the latter will be part of the March 18 policy
