US Fed expected to cut again, despite uncertain path ahead

(MENAFN- AFP)

The US federal Reserve is widely expected to cut interest rates by a quarter point on Wednesday and signal a slower pace of cuts ahead, brushing off uncertainty about inflation's downward path and the possible impact of some of President-elect Donald Trump's economic proposals.

The Fed has made significant progress tackling inflation through interest rate hikes in the last two years, and recently began paring rates back in a bid to boost demand in the Economy and support the labor market.

In the last couple of months, the Fed's favored inflation has ticked higher, moving away from the bank's long-term target of two percent, and raising concern that the battle against inflation is not over.

Nevertheless, the financial markets still overwhelmingly expect the Fed to announce a quarter percentage-point cut on Wednesday, lowering its benchmark lending rate to between 4.25 and 4.50 percent, according to CME Group data.

"If the Fed wasn't going to do that, they would have dissuaded markets of that notion a long time ago," Moody's Analytics chief economist Mark Zandi told AFP on Tuesday.

A cut on Wednesday would be the Fed's third in a row and would leave rates a full percentage point below where they were just three months ago.

"I'm dubious that another cut is necessary," Citigroup global chief economist Nathan Sheets told AFP.

But a rate cut on Wednesday is "very much baked in" at this point, he said.

- The Trump transition -

This is the final planned interest rate decision before Democratic President Joe Biden makes way for Republican Donald Trump, whose economic proposals include tariff hikes, and the mass deportation of millions of undocumented workers.

These proposals, combined with the recent uptick in inflation data, have led some analysts to pare back the number of rate cuts they expect in 2025, predicting that interest rates will need to remain higher for longer.

At its September rate decision, Fed policymakers penciled in four additional quarter-point rate cuts next year.

Many analysts expect Wednesday's updated economic forecasts to show a median expectation of only two or three cuts in 2025.

"They'll be signaling probably three more cuts next year," said Nathan Sheets from Citigroup, adding he also expected the Fed to slightly raise its inflation forecast, given the recent uptick.

Other economists say fewer cuts are likely.

"I don't think they'll cut three times," said Zandi from Moody's. "We might get another rate cut or two next year, but I don't think much more than that."

The futures markets broadly expect that the Fed will pause at the next decision in January 2025, and place a probability of around 70 percent that it will make a total of no more than three quarter-point cuts next year, according to CME Group data.

- The challenge for Powell -

In a recent speech, Fed chair Jerome Powell said the US central bank "can afford to be a little more cautious" going forward as it looks to lower interest rates, given the underlying strength of the US economy.

One big challenge Powell will face during the post-decision press conference on Wednesday is how to defend the Fed's expected vote to cut rates, given that the US economy and the labor market are both in relatively good health, while inflation has ticked higher.

"We expect Powell will indicate that the Committee believed it was appropriate to continue the re-calibration of its monetary policy stance with another modest reduction," economists at Deutsche Bank wrote in a recent investor note.

"The Chair is likely to emphasize that the current policy stance leaves the Committee well placed to respond to risks in both directions," they added.

Another big task facing the Fed chair is how to deal with the prospect of some dramatic economic changes once Donald Trump takes office on January 20th.

The Fed has a dual mandate from Congress to act independently to tackle inflation and unemployment. But it still has to deal with the implications of government policies on the broader economy.

"I think it is possible -- conceptually possible -- to have a baseline that's agnostic as to Trump's policies," said Sheets from Citigroup. "And I think that that is the way that Powell is going to try to sell it."

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