Fed Cuts Rates; Uncertainty Ahead

As expected, the Federal Reserve proceeded with another interest rate cut of 0.25 percentage points at today’s meeting. This continues the round of cuts begun at the FOMC meeting in September, which marked a resumption in easing after a hiatus following the December 2024 meeting.

The federal-funds rate now stands at a target range of 3.75%-4.00%. Altogether, the Fed has cut by 1.5 percentage points since September 2024 (1 point in autumn 2024 and 0.5 points this year). Prior to that, the rate had been quite elevated at 5.25%-5.50% from July 2023 to September 2024. While the rate has come down, it’s still significantly above the prepandemic (2017-19) average of 1.7%.

On Wednesday afternoon, the 10-year Treasury yield rose to 4.07% from 3.98% on Tuesday, while the 2-year yield rose to 3.59% from 3.49%.

Fed Less Concerned About Inflation, but Jobs Remain a Risk

The Fed is short on new economic data since the beginning of the federal shutdown on Oct. 1. One exception is the latest Consumer Price Index data, which showed inflation slightly elevated in September, but not alarmingly so. Tariffs are exerting some upward pressure on goods prices, but it’s plausible that this will be a onetime impact and inflation will recede in the next year or so.

Core PCE, which is the Fed’s preferred measure of inflation, is likely to stand at 2.8% year over year as of September, or perhaps around 2.4% if not for the tariff impact. That’s not much above the Fed’s 2% target.

Meanwhile, the latest jobs data before the shutdown showed deteriorating conditions in the labor market. The Fed has judged (correctly, in our view) that increased downside risk to its goal of full employment and inflation being only modestly above target call for a reduction in the federal-funds rate from levels which had been fairly restrictive.

Coming out of last month’s meeting, markets had priced in another cut at this month’s meeting with very high probability. Still, the decision wasn’t unanimous. Ten of the 12 FOMC members voted for today’s cut. The recently appointed Stephen Miran voted for a 0.5-point cut, while Jeffrey Schmid voted for no cut.

December Rate Cut is Uncertain

We’re likely to see more dissent in the FOMC ahead, with a high degree of uncertainty as to the path forward. The two parts of the Fed’s mandate are pulling in opposite directions. Inflation is still above target, which calls for more restrictive monetary policy, while full employment looks in jeopardy, which calls for the opposite. Different participants will weigh these risks differently.

Additionally, the data conflicts on the employment part of the mandate. While employment growth has slowed to a crawl, this conflicts with continued robust GDP growth. As discussed recently by Fed governor (and possible next chair) Christopher Waller, this gap is unlikely to persist indefinitely. Either job growth will eventually re-accelerate with robust GDP growth or the labor market will drag down GDP with it. The latter scenario is persuading the Fed to cut rates.

These two factors will hold even if the US government shutdown is soon resolved. Of course, if the shutdown persists, the uncertainty stemming from a lack of up-to-date data could make the December extraordinary difficult. Powell emphasized today that a cut then is “not a forgone conclusion.” Prior to today, the market-implied probability of a cut in December had been near 90%, but Powell’s remarks helped shift the probability down to around two-thirds as of this afternoon.

The Fed also announced today that it will cease quantitative tightening (the reduction of its long-term asset portfolio) as of Dec. 1. This decision isn’t too consequential, as an eventual cessation had been expected and asset sales had already slowed greatly in recent months.