Washington, D.C. CNN –
The Federal Reserve is expected to announce on Wednesday that it will keep its key interest rate steady at 22-year highs for the third straight day. Central bank officials will also release a series of new economic forecasts that are likely to show inflation cooling more quickly than previously thought and a further rate cut next year or more.
The Fed's statement after the meeting could also indicate that the central bank is not inclined to raise interest rates again, particularly by foregoing the usual “additional monetary tightening” language, although this change could also come at a future meeting.
Fed Chairman Jerome Powell is expected to weigh in on the possibility of rate cuts that could begin in just a few months and reiterate that more rate hikes are still on the table. He tried it earlier this month.
“I’ve come so far so quickly [Fed] is proceeding cautiously as the risks of under- and over-tightening become more balanced,” Powell said during a discussion in Atlanta. “It would be premature to conclude with confidence that we have reached a sufficiently restrictive stance, or to speculate about when the policy might be relaxed.”
However, any additional interest rate increases are not reflected in the futures. Stocks rallied following Powell's hawkish comments in Atlanta. In fact, investors are already looking to the Fed to cut interest rates sometime next year, but when the rate cuts will begin remains unclear. Markets are currently pricing in around a 40% chance that the first rate cut will occur in March.
The Fed is lowering its federal funds rate for two main reasons; because unemployment is rising due to a weakening economy or because there is simply no reason to keep interest rates high at “restrictive” levels when it is clear that inflation is under control. In the latter scenario, if inflation slows and interest rates remain high, this would mean inflation-adjusted “real” interest rates rising, putting unnecessary strain on the economy.
Fed officials' most recent economic forecasts, released in September, showed they will begin cutting interest rates sometime next year. However, it remains unclear when rate cuts will ultimately begin and how often the Fed will cut them in 2024. Economists' estimates of interest rate cuts vary.
“The Fed is increasingly confident that the economy, jobs and inflation are all moving in the right direction, which is consistent with the current interest rate,” Mark Zandi, chief economist at Moody's Analytics, told CNN.
“But futures markets are expecting a lot of cuts next year, starting in March. That's probably too aggressive from the Fed's perspective, so Powell may try to nudge markets toward less aggressive rate cuts next year,” he said.
It remains unclear whether a deteriorating economy or a decline in inflation will lead to interest rate cuts next year.
And with markets already sending clear signals for rate cuts, Fed officials could discuss this during their ongoing policy meeting that began on Tuesday.
“Powell will be asked whether or not they discussed rate cuts at this meeting, and that will be one of the toughest questions for him,” Diane Swonk, chief economist at KPMG, told CNN.
“We will see it in the record, but if so, he has to admit it. He's pretty good at containing the problems in advance, so I expect him to say he'll hold off rate cut talks until January,” she added.
Nor is it just Powell decrying the rate-cutting discourse.
“I’m not thinking about cutting interest rates at all right now,” Mary Daly, president of the San Francisco Fed, told a German newspaper last month. “I'm thinking about whether we have enough tightening in the system and are sufficiently restrictive to restore price stability.”
Inflation remains a vexing problem for the Fed.
Price increases slowed slightly in November as underlying inflationary pressures persisted, according to the Labor Department's latest consumer price index released Tuesday.
The CPI rose 3.1% in November compared to a year earlier, slightly lower than October's 3.2% increase and still above the Fed's 2% target. Meanwhile, excluding fluctuating food and energy prices, the core measure rose 4% in the 12 months ended November, the same as in October.
Still, the latest CPI reflects a significant improvement from its four-decade high in June 2022. The Fed's preferred inflation indicator has shown the same steady progress over the past year.
The latest move in the Fed's inflation fight could be the most difficult, potentially requiring a further slowdown in the economy, and Powell and other Fed officials have already said as much.
Economic growth has already slowed dramatically from the rapid pace in the third quarter.
The Atlanta Fed currently expects fourth-quarter GDP to be 1.2% annualized, down sharply from the red-hot 5.2% in the third quarter.
The labor market has also slowed significantly, at least compared to the robust years of 2021 and 2022. Employers added 199,000 jobs in November as the unemployment rate fell slightly to 3.7% that month. That's above the minimum number of monthly job gains — somewhere between 70,000 and 100,000 — needed to keep pace with population growth.
Overall, the US economy remains resilient and has so far managed to avoid a recession. Instead, it raises even more hopes that the Fed could achieve a soft landing – a situation in which inflation slows without causing a sharp rise in unemployment.
But a soft landing is still not guaranteed.
“We're seeing signs that the economy has essentially already hit a soft landing if you look at the three-month or six-month averages,” Gregory Daco, chief economist at EY-Parthenon, told CNN. “The crucial question now is whether there is a sufficiently long and stable path to 2024 to avoid the long-feared recession.”