The Fed’s Dilemma — Evening Brief – 11.21.24
Monetary policy hawks and doves at the Federal Reserve can cite plenty of evidence to back up their positions. Although policymakers rely on data, awaiting those signals may jeopardize the central bank’s achievements in controlling inflation without adversely affecting economic growth. Conversely, one could contend that policy remains restrictive for an economy that seems to be decelerating, albeit slightly.
Policymakers are attempting to convey assurance regarding a potentially challenging future. Susan Collins, President of the Federal Reserve Bank of Boston, stated on Wednesday that “some” additional interest-rate cuts are required. However, she is of the opinion that the Fed should exercise caution when it comes to easing in an excessive or rapid manner.
“While the final destination is uncertain, I believe some additional policy easing is needed, as policy currently remains at least somewhat restrictive,” Collins said in remarks prepared for delivery at the University of Michigan’s Gerald R. Ford School of Public Policy in Ann Arbor.
Collins’ perspective appears to be consistent with the price movement of the U.S. 2-year Treasury yield, which is currently trading at 4.33% and below the Fed fund target range of 4.50% to 4.75%. However, the negative spread has narrowed significantly over the past two months and is now a modest -25 basis points, indicating that a quarter-point rate reduction at next month’s policy meeting is plausible. Fed funds futures currently price in a 59% implied probability of a quarter-point cut at the December 18 FOMC meeting.
The FOMC faces a dilemma as the most recent inflation data indicates that pricing pressures have resumed their “stickiness,” making it premature to reduce interest rates again. Headline and core CPI readings increased in year-over-year terms through October, heightening concerns that obstacles may be accumulating in achieving the Fed’s 2% inflation target.
Federal Reserve Governor Michelle Bowman said Wednesday that the Fed “should pursue a cautious approach” to further monetary easing given persistent inflationary pressures.
“I would prefer to proceed cautiously in bringing the policy rate down to better assess how far we are from the end point, while recognizing that we have not yet achieved our inflation goal and closely watching the evolution of the labor market,” Bowman said in a prepared speech in West Palm Beach, FL.
The outlook is more complicated by president-elect Trump’s intentions to significantly increase import tariffs, which numerous economists anticipate would elevate inflation.
At the same time, various forecasts for U.S. economic growth in the fourth quarter indicate a persistent, albeit gradual, deceleration. The Atlanta Fed’s GDPNow model, for example, is presently forecasting a decrease to +2.6% for the fourth quarter.
The Federal Reserve faces a risk due to two distinct economic scenarios that may unfold in 2025, each differing significantly from the other. Uncertainty regarding the upcoming year has surged. Consequently, the Fed will be compelled to undertake a calculated risk soon.