Federal Reserve Expected to Keep Interest Rates Unchanged Amid Speculation of Future Rate Cuts

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As inflation inches closer to the Federal Reserve’s target of 2%, there is growing speculation about the possibility of the central bank implementing interest rate cuts in the coming year, potentially as early as spring. Such a move would have broad implications, including reducing borrowing costs across the economy, making mortgages, auto loans, and business borrowing more affordable. It could also boost stock prices, although anticipation of rate cuts has already driven up share prices, potentially limiting further gains.

Federal Reserve Chair Jerome Powell, however, has recently downplayed the likelihood of imminent rate reductions. With the central bank’s upcoming meeting expected to result in no change to its key short-term rate, Powell has refrained from signaling that the Fed has definitively concluded its series of rate hikes. Speaking at Spelman College in Atlanta, Powell cautioned against prematurely assuming that the Fed has raised its benchmark rate sufficiently to combat inflation effectively.

Nonetheless, the Fed’s upcoming two-day meeting, concluding this week, will mark the third consecutive occasion during which it keeps its key rate unchanged. This consistency lends credence to the prevailing belief that rate hikes are now behind us.

The U.S. economy appears to be aligning with the Fed’s objectives. The forthcoming November inflation report is anticipated to reveal a slowdown in annual consumer price increases to 3.1%, down significantly from a peak of 9.1% in June 2022, according to economists surveyed by FactSet. Moreover, job openings have decreased, indicating reduced urgency among companies to hire and less pressure to substantially raise wages, which can contribute to inflation. While consumer spending remains active but more moderate, the overall economy continues to expand.

These trends signify progress toward achieving a “soft landing,” wherein inflation reaches the Fed’s 2% target without precipitating a recession. Economists are increasingly optimistic about the notably smooth adjustment to lower inflation, a departure from the prior belief that conquering inflation would necessitate a severe recession and high unemployment. Goldman Sachs economists noted that witnessing declining inflation without accompanying recession or job losses is historically unprecedented.

Austan Goolsbee, President of the Federal Reserve Bank of Chicago, observed that the United States is on track for the fastest annual decline in inflation on record this year. If this trend persists, Goolsbee suggested that it could lead to a “bigger soft landing than conventional wisdom believes has ever been possible.”

Nevertheless, a soft landing is not without risks. If the Fed misjudges and maintains interest rates at elevated levels for too long, it could potentially disrupt the economy and push it into a recession. Julia Coronado, President of MarcoPolicy Perspectives, an economic research firm, expressed concern that there is a greater risk of a recession than a resurgence of inflation at current interest rates, making a rate cut a probable next move.

The timing of any rate cuts will hinge on the state of the economy. A recession or the looming threat of one would likely prompt more immediate interest rate reductions by the Fed. However, the recent November jobs report, which revealed robust job growth and a decrease in the unemployment rate to 3.7%, suggests that the long-anticipated recession is not imminent. Consequently, investors have adjusted their expectations for the first Fed rate cut from March to May.

The Fed may opt to lower rates this year even if the economy continues to perform well, provided inflation keeps receding. This action would counteract the rise in inflation-adjusted interest rates, preventing borrowing costs from exceeding the Fed’s intentions. However, economists caution that rate cuts in response to decreasing inflation may take longer than anticipated by Wall Street, as the Fed would want to confirm that inflation remains under control.

Jim Bullard, former President of the Federal Reserve Bank of St. Louis and current Dean of Purdue University’s business school, emphasized the need for caution regarding rate cuts. Premature cuts, followed by a resurgence of inflation, have been held responsible for the Fed’s inability to curb inflation in the 1970s. Bullard suggested that if job growth and economic expansion continue positively, rate cuts may not be necessary in the near future.

In any case, the Fed’s quarterly economic projections, to be released this Wednesday, will include forecasts of its policymakers regarding their key rate’s status at the end of 2024. Some experts anticipate only two rate cuts to be outlined, half the number expected by financial markets at present. If the Fed does decide to cut rates twice in 2024, the first cut may not materialize until late in the year, according to Nancy Vanden Houten, lead U.S. economist at Oxford Economics. She emphasized the Fed’s likely cautious approach, suggesting that it would be several months before rate cuts are seriously considered.

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