The annual rotation on the U.S. Federal Reserve’s interest-rate-setting committee means that its 2024 voting members are slightly more hawkish compared to the outgoing group from 2023. However, this shift in membership is unlikely to alter the outlook for a pivot to interest-rate cuts next year. In fact, if inflation continues to fall more quickly than expected, Fed policymakers may want to reduce rates even more than the projected three-quarters-of-a-percentage point. The recent release of the personal consumption expenditures price index, the Fed’s preferred measure of inflation, further strengthens the case for rate cuts. This article analyzes the factors influencing the Fed’s decision on rate cuts and the potential implications for the economy.
Over the second half of the year, the sentiment at the Fed policymaking table has shifted towards a more dovish stance. This change in sentiment is driven by increasing evidence of easing price pressures and a cooling labor market in response to the Fed’s previous rate hikes. Even the policymakers who had previously advocated for rate hikes, such as Fed Governor Christopher Waller, have revised their views. As the risks to inflation diminish, policymakers are reevaluating their stance and considering the need for rate cuts.
Following the decision to keep rates steady, Fed Chair Jerome Powell signaled that the timing of rate cuts would be the next question for the central bank. This announcement led to a plunge in bond yields and market expectations of rapid-fire policy rate reductions starting in March. Powell’s change in tone has influenced market expectations and indicates that the Fed may be considering more than the initially projected three-quarters-of-a-percentage point rate cuts. The move to signal easier policy ahead aims to address potential disinflationary dynamics within the economy and prevent tightening conditions.
There are two primary reasons for rate cuts next year. Firstly, as inflation falls, holding the benchmark rate steady would result in higher real borrowing costs. To prevent overtightening, the Fed may need to reduce its policy rate. Secondly, lower inflation may make it challenging for firms to raise prices. To protect their profits, these firms may resort to trimming labor costs, potentially leading to job losses. Signaling rate cuts helps to offset these “nasty” disinflationary dynamics and supports economic stability.
Fed Voter Rotation
The rotation of Fed bank presidents who hold voting rights in 2024 is expected to be less inclined towards rate cuts compared to their predecessors from 2023. Economists believe that the incoming voting members, including Raphael Bostic, the chief of the Atlanta Fed, and Cleveland Fed President Loretta Mester, may support fewer rate cuts. However, projections published last week indicate that most policymakers expect a lower range of rates next year. The opinions of the voting members may change based on evolving factors and economic data.
Several evolving factors could affect the Fed’s decision on rates. Factors such as an extended disruption of traffic through the Suez Canal due to militant attacks, a rise in consumer confidence, easier financial conditions, and stronger-than-expected job growth may impact inflation progress. These factors could potentially rekindle the hawkish bias among policymakers. However, the Fed is unlikely to adjust its policies in response to short-term geopolitical shocks. Additionally, with the current policy rate already high, weaker spending and job gains are expected next year.
While the rotation of voting members on the Fed’s interest-rate-setting committee may suggest a more hawkish outlook, rate cuts remain on the horizon. The Fed’s decision is driven by the need to address easing price pressures, protect against disinflationary dynamics, and adjust borrowing costs in response to falling inflation. The incoming data and evolving economic factors will play a critical role in shaping the Fed’s decisions on rate cuts. However, overall, the consensus among policymakers is leaning towards supporting the projected three quarter-point rate cuts.