With inflation on a steady decline, the Fed is expected to cut interest rates for the second time this year. This decision, however, is not anticipated to be influenced by the outcome of the presidential race, which may still be undecided when the Fed concludes its two-day meeting on Thursday. The future actions of the Fed could become more unpredictable with the inauguration of a new president and Congress in January, especially if President Donald Trump secures a second term.
According to ABC News, Trump's proposed policies, including imposing high tariffs on all imports, initiating mass deportations of unauthorized immigrants, and potentially interfering with the Fed's independent rate decisions, could lead to a surge in inflation. Economists have warned that such a scenario would force the Fed to halt or slow down its rate cuts.
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The Fed's policymakers, under the leadership of Chair Jerome Powell, are expected to reduce their benchmark rate by a quarter-point to approximately 4.6% on Thursday. This follows a half-point reduction in September. Economists predict another quarter-point rate cut in December and possibly more in the coming year. Over time, these rate cuts are likely to decrease borrowing costs for consumers and businesses.
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Contrary to its usual practice of cutting rates to stimulate a sluggish economy and weak job market, the Fed is lowering rates in response to a lower-inflation environment. This is part of what Powell has described as “a recalibration.” The economy is currently growing at a healthy rate, and the unemployment rate is a low 4.1%, despite hurricanes and a strike at Boeing that significantly reduced net job growth last month.
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In June 2022, when inflation soared to a four-decade high of 9.1%, the Fed responded by raising rates 11 times, pushing its key rate to about 5.3%, the highest in four decades. However, by September, year-over-year inflation had dropped to 2.4%, barely above the Fed's 2% target and equal to its 2018 level. With inflation having fallen so significantly, Powell and other Fed officials believe high borrowing rates are no longer necessary. High borrowing rates typically hinder growth, especially in sectors sensitive to interest rates such as housing and auto sales.
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Claudia Sahm, chief economist at New Century Advisors and a former Fed economist, explained, “The restriction was in place because inflation was elevated. Inflation is no longer elevated. The reason for the restriction is gone.”
Fed officials have indicated that their rate cuts would be gradual, but almost all have expressed support for further reductions. Christopher Waller, an influential member of the Fed's Board of Directors, said in a speech last month, “For me, the central question is how much and how fast to reduce the target for the (Fed's key) rate, which I believe is currently set at a restrictive level.”
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Jonathan Pingle, an economist at Swiss bank UBS, noted that Waller's comments reflected “unusual confidence and conviction that rates were headed lower."
In the coming year, the Fed will likely grapple with the question of how low their benchmark rate should go. Eventually, they may aim to set it at a level that neither restricts nor stimulates growth — a “neutral” rate in Fed parlance. Powell and other Fed officials admit that they don't know exactly where the neutral rate is. In September, the Fed's rate-setting committee estimated that it was 2.9%. Most economists believe it's closer to 3% to 3.5%.
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However, some economists argue that with the economy appearing healthy even with high borrowing rates, the Fed doesn't need to ease credit much, if at all. They suggest that the current interest rates may already be close to the level that neither slows nor stimulates the economy. Joe LaVorgna, chief economist at SMBC Nikko Securities, asked, “If the unemployment rate stays in the low 4's and the economy is still going to grow at 3%, does it matter that the (Fed's) rate is 4.75% to 5%? Why are they cutting now?”
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Powell is expected to face questions about the outcome of the presidential race and its potential impact on the economy and inflation at his news conference on Thursday, following the Fed's meeting. He is likely to reiterate that the Fed's decisions are not influenced by politics.
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During Trump's presidency, he imposed tariffs on washing machines, solar panels, steel, and a range of goods from China, which were maintained by President Joe Biden. Although studies show that washing machine prices increased as a result, overall inflation did not rise significantly.
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However, Trump is now proposing significantly broader tariffs — essentially, import taxes — that would raise the prices of about 10 times as many goods from overseas. Many mainstream economists are alarmed by Trump’s latest proposed tariffs, which they say would almost certainly reignite inflation. A report by the Peterson Institute for International Economics concluded that Trump’s main tariff proposals would make inflation 2 percentage points higher next year than it otherwise would have been.
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Economists at Pantheon Macroeconomics suggest that the Fed could be more likely to raise rates in response to tariffs this time, "given that Trump is threatening much bigger increases in tariffs.” They wrote, “Accordingly, we will scale back the reduction in the funds rate in our 2025 forecasts if Trump wins.”
