The U.S. Federal Reserve announced Wednesday it would cut its key interest rate by a quarter of a percentage point in an effort to keep a seemingly stable but cooling economy stable.
The move, the Fed’s third rate cut this year, lowers the central bank’s target interest rate to 4.25% to 4.5%.
In its statement announcing the rate cuts, the Fed currently expects to cut rates only twice in 2025. Unemployment remains low, he said, while inflation “remains somewhat high.” Another document released by the Fed on Wednesday shows central bank officials now believe they won’t be able to reach their 2% inflation target until 2026.
Economists surveyed by Bloomberg had expected three rate cuts next year, believing the economy and price growth would have cooled further by now.
Despite the cautious outlook, Federal Reserve Chairman Jerome Powell was upbeat about the current state of the U.S. economy, especially relative to other countries’ performance.
Chairman Powell said after the announcement that the U.S. economy was “remarkable.” He added: “If you look around the world, there’s a lot of low growth and we’re still struggling with inflation. So we’re very happy with where the economy is.”
The Fed’s moves are aimed at preventing the economy from overheating when growth is strong or sliding into recession when growth is slow. It does this by changing something called the federal funds rate, which helps set borrowing rates for the entire economy. The Fed tries to control the pace of economic growth by making it easier or harder to borrow.
There is currently a heated debate about which is more likely in the future.
For now, the pace of inflation remains well below post-pandemic highs. But last week, the Bureau of Labor Statistics reported that the 12-month Consumer Price Index, the most closely watched inflation measure, rose 2.7% in November, outpacing the previous month’s 2.6% pace.
Consumers don’t seem fazed. On Tuesday, the Census Bureau reported that retail sales rose 0.7% for the month, above expectations of 0.6%, but the October figure was revised upward to 0.5% from 0.4%.
While these data points suggest the economy remains on relatively solid footing, there are some flashing warning signs about fundamental weaknesses. This would justify the accommodative monetary policy sought by the Fed, not to mention President-elect Donald Trump.
The biggest concern is the labor market, with job growth largely concentrated in sectors such as health care and state and local government. These sectors tend to say little about our place in the business cycle.
Meanwhile, employment growth in sectors that typically exhibit continued growth, such as manufacturing, business, and professional services, has remained roughly flat.
Overall, hiring rates have plummeted and the number of job openings continues to decline.
Finally, after an incredible bull market for much of 2024, some stock indexes are retreating from their all-time highs. The Dow Jones Industrial Average has fallen for nine straight days, its worst multi-day performance since the 1970s.
Market participants now overwhelmingly believe that the Fed will “pause” interest rates and leave them unchanged at its January meeting to assess the overall financial situation after announcing a quarter-point rate cut in December. I believe in
For the most part, analysts have a relatively optimistic view of the current situation. The Fed remains likely to achieve a “soft landing” for the U.S. economy with relatively low unemployment and inflation, according to a new study from Bank of America.
But if anything, inflation is expected to have fallen further by now, according to Goldman Sachs analysts, at the expense of a slight rise in unemployment.
“The unemployment rate is not rising as rapidly as it was earlier this fall,” these analysts said in a graph attached to a recent client note. Still, they said, “it is premature to conclude that broad-based labor market data have stabilized convincingly.”
Despite a still volatile labor market, Federal Reserve officials plan to reduce cuts in the near term, not only in response to rising inflation but also in light of the uncertainty of the incoming Trump administration’s tariff policy. That suggests they may want to slow down.
To explain the Fed’s thinking, Goldman analysts pointed to a speech this month by Cleveland Fed President Beth Hammack explaining the situation.
“Resilient growth, a healthy labor market, and still-high inflation suggest that maintaining a moderately restrictive stance on monetary policy remains appropriate for the foreseeable future,” Hammack said. “Such a policy stance would help bring inflation back to 2% in a timely and sustained manner.”
There is also a broader rethinking of whether interest rates should be raised in general, given the structural changes in the economy that lead to faster growth, such as large budget deficits and higher productivity growth.
Hammack said the 2008 financial crisis set the stage for more than a decade of low interest rates, but that “some of the forces that appeared to be suppressing neutral interest rates after the global financial crisis have finally stopped the trend. There is a possibility that the situation has reversed.”
Investor and economist sentiment has also heightened uncertainty about how the Trump administration will affect the economy. In particular, there are widespread concerns about price increases due to tariffs.
“When it rains, it rains on everyone,” Costco Chief Financial Officer Gary Millerchip said during the company’s latest earnings call.
Still, the base case looks relatively smooth sailing, thanks in large part to President Trump’s pro-business policies. A Bank of America survey found that 33% of respondents expect the economy to continue to grow steadily, the highest level in eight months, as well as 33% of respondents expecting a recession scenario. was just 6%, the lowest level in six months. On the other hand, overall investor sentiment remains “super bullish”, with capital being allocated to stocks at high prices and cash at low prices due to expectations for continued consumption and cheaper financing after President Trump’s inauguration.
Ironically, when sentiment reaches that level, it is usually a sell signal, Bank of America said in a note.
