Jerome Powell, Chairman of the Federal Reserve, faces a pivotal moment as the central bank prepares for its upcoming policy meeting. The latest jobs report has all but cemented expectations of an interest rate cut later this month, with market indicators assigning nearly a 90% probability to such a move. However, whether the Fed should proceed with the cut and how it navigates monetary policy afterward remain open questions, sparking heated debate among economists and policymakers.
The November employment data presented a balanced picture, neither overly strong nor overly weak, providing the Fed with the flexibility to justify a rate cut. Non-farm payrolls increased by 227,000, a significant improvement from October’s hurricane- and strike-affected 36,000. This averages out to about 131,500 new jobs over the past two months, a figure slightly below the trend seen earlier this year. Despite this, the labor market remains resilient, with unemployment ticking up to 4.2% and household employment contracting slightly.
While these data points seem to support a rate cut, not everyone agrees it’s the right move. Critics warn of potential risks, such as fueling speculative bubbles in financial markets or undermining the Fed’s credibility in its fight against inflation. Joseph LaVorgna, chief economist at SMBC Nikko Securities, argued that financial conditions have eased significantly in recent months and cautioned against cutting rates too soon. “There’s no reason to cut rates right now. They should take a break,” LaVorgna said, emphasizing the risk of creating instability in asset markets.
Similarly, Chris Rupkey, senior economist at FWDBONDS, questioned the necessity of further rate reductions, especially given the robust job market. Rupkey pointed out that the Fed’s decision to continue its easing cycle could be perceived as premature, particularly as inflation remains above target. Jason Furman, a former White House economist under Barack Obama, echoed these concerns, noting that wage growth—currently at 4%—is consistent with an inflation rate of 3.5%, well above the Fed’s 2% goal.
“This is another no-landing scenario,” Furman remarked, referring to an economic environment where growth persists despite higher inflation risks. He added, “I have no doubt the Fed will cut again, but the timing of future cuts beyond December is uncertain. It will likely take more than a moderate rise in unemployment to prompt additional action.”
Weighing the factors
The Fed’s decision is further complicated by other economic indicators. Inflation, as measured by the Fed’s preferred gauge, rose to 2.3% in October, or 2.8% when excluding volatile food and energy prices. This marks a slight uptick, signaling that inflationary pressures haven’t fully receded. Wage growth also remains elevated relative to pre-pandemic levels, further complicating the Fed’s calculus.
Adding to the equation is the overall strength of the economy. The Atlanta Fed estimates that the fourth quarter will deliver an annualized GDP growth rate of 3.3%, underscoring the resilience of the U.S. economy. Financial conditions, which encompass metrics like bond yields, stock prices, and mortgage rates, have loosened to levels not seen since early 2023, despite the Fed maintaining its benchmark rate in a “tight” range of 4.5% to 4.75%.
Fed Chair Jerome Powell has acknowledged these dynamics, recently describing the U.S. economy as the “envy of the developed world.” His remarks suggest that the central bank has room to proceed cautiously as it recalibrates monetary policy. However, not all Fed officials share the same level of optimism.
Cleveland Fed President Beth Hammack, for instance, has advocated for a more measured approach to rate cuts. Speaking on Friday, Hammack highlighted strong economic growth but emphasized the need for more evidence that inflation is moving decisively toward the Fed’s 2% target. “To balance the need to maintain a moderately restrictive stance on monetary policy with the possibility that policy is not far from being neutral, I believe we are at the point, or close to it, where it makes sense to slow the pace of rate cuts,” she said.
The question of neutrality
The concept of the “neutral” interest rate—one that neither stimulates nor restricts economic growth—is central to the Fed’s current policy debate. Recent indications suggest that this neutral level may be higher than in previous economic cycles, further complicating the Fed’s decision-making process.
The Fed’s next steps could involve implementing the December rate cut, pausing in January, and potentially cutting rates again in early 2025. Tom Porcelli, chief U.S. economist at PFIM Fixed Income, believes this is a likely scenario. “I don’t think there’s anything in today’s data that would actually stop them from cutting in December,” Porcelli said. He argued that the Fed’s aggressive rate hikes in 2022 were designed for a much different inflationary environment than the one currently in place. “In that context, Powell would want to continue the process of normalizing policy,” he added.
Powell and other Fed officials have acknowledged a shift in focus. While inflation control remains a priority, there is now greater emphasis on supporting the labor market and avoiding unnecessary disruptions to economic growth. Porcelli cautioned against waiting too long to adjust policy, noting that delaying rate cuts until the labor market shows significant cracks could be too late. “Prudence would really dictate starting this process now,” he said.
What lies ahead
One potential obstacle to the December rate cut is next week’s release of inflation data, including reports on consumer and producer prices. The Consumer Price Index (CPI) is expected to show a 2.7% increase, a figure that could influence the Fed’s deliberations. After Friday, Fed officials will enter a “quiet period,” refraining from public commentary until after the policy meeting.
The broader question for the Fed is how to navigate the fine line between easing monetary policy to sustain growth and maintaining credibility in its inflation-fighting mandate. Recent data suggest that the central bank may be nearing the point where policy becomes neutral, but the exact timing and magnitude of future rate cuts remain uncertain.
In the coming weeks, Powell and his colleagues will weigh these competing factors in what could be one of the most consequential decisions of the year. The outcome will not only shape monetary policy in the short term but also set the tone for how the Fed approaches its dual mandate of price stability and full employment in a post-pandemic economy.
As the December meeting looms, the Fed faces a delicate balancing act. With the economy showing resilience but inflationary pressures lingering, the central bank must carefully calibrate its actions to avoid overcorrecting. Whether this translates into a decisive pivot or a more cautious approach remains to be seen, but one thing is clear: the decisions made in the coming weeks will have far-reaching implications for the U.S. economy and beyond.
