The Federal Reserve will be facing the difficult choice of either aggressively fighting inflation or hoping to revive a sluggish labor market and slowing economic activity when it meets on Tuesday and Wednesday.
Inflation has yet to reach the Fed’s 2% inflation target, and consumers have taken notice. We expect the Federal Open Market Committee’s Summary of Economic Projections, which will be released at the meeting, to show that the committee does not expect to reach that target until 2028.
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A survey by the Federal Reserve Bank of New York taken in November indicates that consumer expectations for inflation in one year have recently hovered around 3.2%, and have been at 3% or higher for 12 consecutive months.
At the same time, the percentage of households anticipating a worsening financial situation in one year has been 30% or greater in all but two of the past nine months.
Inflation tends to feed on itself, with households prone to buying more before prices rise again, which pressures prices even higher.
This dynamic may partially explain why the demand for services remains sticky and is offsetting disinflation in other areas of the economy.
While none of the models that we run to estimate the Fed’s optimal policy rate implies that a rate reduction is appropriate at this time, we expect the FOMC to cut its policy rate on Wednesday.
From our vantage point, the Fed has always considered inflation most damaging for middle- and lower-income households, and that is why price stability is a pre-condition of maximum sustainable employment.
For now, with growth in the final quarter likely to arrive well below the 1.8% long-term trend and hiring to slow over the next few months, the Fed appears predisposed to put in place a bit of downside insurance despite the fiscal stimulus set to arrive in 2026.
