The financial markets are experiencing a festive mood today, akin to Christmas morning. The central question is whether their desire for a December interest rate reduction, orchestrated by Jerome Powell, will be fulfilled. Current indicators suggest this outcome is probable.
Investors priced in an 87.6% likelihood of a reduction from the Federal Open Market Committee (FOMC) this afternoon, down by 25 basis points to 3.5 to 3.75%. The data has been laying the tracks for such a cut, though speculators also warned last week ahead of the Fed meeting that the committee may be more divided than usual in their outlook on the economy.
Ultimately, the Federal Reserve is tasked with two primary objectives: keeping inflation at 2% and guaranteeing a steady unemployment rate. These goals are becoming more difficult to reconcile. Inflation is proving stubborn at 3%, and concurrently, the unemployment rate has climbed to 4.4% over recent months.
TL;DR
- Markets anticipate an 87.6% chance of a 25 basis point interest rate reduction by the FOMC today.
- The Federal Reserve faces a challenge balancing 2% inflation and a rising 4.4% unemployment rate.
- A rate cut is likely intended for labor market stabilization, not economic stimulation, according to economists.
- Economists suggest the Fed is providing "downside insurance" against a weakening labor market and economy.
While a reduction by The Federal Reserve typically energizes financial markets by providing cheaper access to funds and consequently stimulating economic expansion, a rate decrease this month appears aimed more at stabilizing the situation rather than accelerating underlying economic momentum.
The cut is “probably not meant to be stimulatory,” said UBS chief economist Paul Donovan in a note to clients this morning. He said: “It would be strange to stimulate as U.S. Inflation creeps higher, and most projections suggest it has higher to go before it peaks. However, there is little that the Fed can do to directly change the inflation consequences of either supply shocks or trade tariffs. It could offset them by causing deflation in other areas of the U.S. Economy, but that might be considered an excessively high amount of economic damage to levy.”
He stated: “Ignoring the inflation it cannot help without stimulating inflation in areas it can influence seems the most sensible course of action.” The Federal Reserve's choice, consequently, needs to concentrate on the employment aspect of its directive.
A laceration is somewhat of a “insurance policy against a shattering of the U.S. Labor market,” Donovan remarked, “so much of the U.S. Growth outlook depends on keeping the fear of unemployment suitably low.”
This is due to concerns that as unemployment rises, consumers might reduce their spending during a period when the government is making substantial fiscal investments.
Joe Brusuelas, RSM's chief economist, also anticipates a reduction today. He cautioned: “none of the models that we run to estimate the Fed’s optimal policy rate implies that a rate reduction is appropriate at this time.” Nevertheless, “growth in the final quarter is likely to arrive well below the 1.8% long-term trend and hiring is set to slow over the next few months. The Fed appears predisposed to put in place a bit of downside insurance despite the fiscal stimulus set to arrive in 2026.”
A foregone conclusion
Investors looking to convince themselves of an imminent cut may already have a shred of evidence, Donovan added: “If one wants to engage in conspiracy theories, one might suggest that the fact the Fed did not delay the meeting until after the missing employment data was released, is a signal that the Fed chair is sufficiently confident in the outcome as to be happy to move without much new information.”
“The Federal Reserve appears set to cut interest rates at the conclusion of the December meeting, bucking the assumption embedded in the baseline forecast,” chimed Ryan Sweet, Global Chief Economist at Oxford Economics. “A cut of 25 basis points in December wouldn’t alter the contours of the forecast for GDP, unemployment, or inflation next year.”
However, it does affect the capacity for additional reductions in 2026, he stated. Should the Fed decide to reduce rates today, Sweet commented, “we’ll remove the March cut in the January baseline because the central bank will want time to gauge how past cuts are impacting the economy.”
