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The US Federal Reserve is widely expected to cut interest rates by 25 basis points at its meeting next week. It would be the third rate cut by the Fed this year but many economists believe that the US central bank would pause rate cuts for a while after the December cut.
The Fed began its tightening spree in 2022 starting with 25 basis points in March 2022 followed by 50 basis points in May. In the next four meetings of 2022, it raised rates by 75 basis points – a pace not seen in years – but toned down the hike to 50 basis points in December. The US central bank raised rates four times in 2023 by 25 basis points each to lift the policy rates to the highest since 2007.
Meanwhile, as inflation gradually came down to more comfortable levels – even if still higher than the 2% that it targets – the Fed began easing rates and has cut rates twice this year.
According to the CME Fed Watch Tool, the odds of a 25 basis point rate at the Fed’s December meeting are 96% while the remaining see rates at current levels.
A December Rate Cut Looks Like a Done Deal
A December rate cut looks like a done deal even as inflation hasn’t yet fallen to the levels that the Fed targets. In his note, Michael Gapen, Morgan Stanley’s chief economist said, “A 25bp rate cut in December is baked in the cake.”
He added, “The Fed will communicate more cuts are coming, but the question is when and how many.” Gapen said that the Fed would be cautious about the rate cuts going forward.
Jacob Channel, senior economic analyst at LendingTree also echoed similar views and said that the US central bank would take “a wait-and-see” approach to rate cuts after the December cut. “This could be the last cut for a while,” said Channel.
Trump’s Tariffs Could Complicate the Picture
While US inflation has gradually come down after peaking in mid-2022, there are risks that Trump’s trade war could push up prices. The president-elect has vowed to impose tariffs on goods coming from countries ranging from Canada to China which could have some inflationary impact. While in his first tenure, Trump claimed that the tariffs are borne by exporting countries, economists disagree and say that they are borne by the US consumer.
In a recent interview, Trump said that he cannot “guarantee” that his tariffs won’t hurt Americans.
Current Treasury Secretary Janet Yellen also believes that tariffs would be destabilizing. According to Yellen, “So it would have an adverse impact on the competitiveness of some sectors of the United States economy and could significantly raise costs to households.” He added, “So this is a strategy I worry could derail the progress that we’ve made on inflation and have adverse consequences on growth.”
Yellen Warns on Fiscal Deficit
Yellen also warned about the soaring budget deficit and said, “I am concerned about fiscal sustainability, and I am sorry that we haven’t made more progress.” She added, “I believe that the deficit needs to be brought down, especially now that we’re in an environment of higher interest rates.” Notably, the US would pay upwards of $1 trillion as interest on the Federal government’s massive borrowing.
Fed Chair Jerome Powell Warned of Unsustainable Debt Position
Last fiscal year, the US budget deficit was $1.8 trillion, and while it is below the pandemic highs, the deficit is significantly higher than what it was prior to the pandemic.
There hasn’t been any respite this fiscal year and in the first two months, the US budget deficit soared 64% YoY to $624 billion.
Fed chair Jerome Powell has also talked about the need to address the rising US debt situation. In his interview with CBS 60 Minutes earlier this year, he said, “The U.S. federal government is on an unsustainable fiscal path. And that just means that the debt is growing faster than the economy.”
He added, “I think the pandemic was a very special event, and it caused the government to really spend to ward off what looked like very severe downside risks. It’s probably time, or past time, to get back to an adult conversation among elected officials about getting the federal government back on a sustainable fiscal path.”
Trump Said He Won’t Try to Remove Powell as Fed Chair
The Fed chair warned, “we’re effectively — we’re borrowing from future generations. And every generation really should pay for the things that it, that it needs. It can cause the federal government to buy the things that it needs for it, but it really should pay for those things and not hand the bills to our children and grandchildren.”
Notably, while Trump appointed Powell as the Fed chair the relations between the two were quite fraught as Powell raised rates during Trump’s presidency, much to his displeasure. In 2022, Joe Biden repointed Powell as the Fed chair for four years and Trump has said that he won’t try to remove him from the position. Powell too has no plans to step down from his position.
All said, given the uncertainty over the geopolitical situation and Trump’s tariffs, the Fed might take a more cautious stance toward rate cuts at least in the first half of the next year. Traders are also quite divided over the Fed’s policy in 2025 and while a third of the traders see the US central bank cutting rates by 75 basis points next year, 26.6% see only a 50 basis point rate cut.
