Today It’s the FOMC’s Turn

Like them or not, the folks at the Federal Reserve had some foresight when it came to planning today’s meeting.  The FOMC meets eight times a year, so most meetings are six weeks apart with results on Wednesdays.  Rather than making an interest rate decision while markets were digesting the results of a Presidential election, the Fed helpfully pushed it forward to today. 

It would truly be a shock if the FOMC did anything other than cut rates by 25 basis points.  Powell’s Fed is loath to surprise markets, and with Fed Funds futures pricing in almost perfect certainty for a cut of that magnitude, it would be quite stunning if today’s baseline result differed at all.  By no means does that imply a lack of potential drama today though.

Market expectations for future rate cuts have changed markedly since the 50bp cut at the prior meeting.  There was some legitimate uncertainty about whether the FOMC would begin its rate cutting cycle with 25 or 50bp, and of course we know that they chose the larger cut.  Traders once again became euphoric about the potential for future cuts.  On the day after the September 18^th meeting, futures were pricing in a rate of 2.85% for December 2025.  The current expectation is for 3.71%, nearly a full point higher.  That is a significant change in opinion over a short time span.

The change in sentiment is understandable.  The need for an aggressive cut was based upon perceptions of a slowing labor economy.   Since then, investors had reason to question whether employment is in decline or simply slowing its growth.  In a podcast conversation with my colleague Jose Torres, taped Monday, we had the following exchange:

SS: [A]re we seeing some sort of, what I’m going to call the equivalent of disinflation in the labor market. Whereas things are not growing as quickly, but they’re still doing fine. Just as with disinflation being the change in the change of prices, the second derivative of prices, as it were.  Is that kind of what we’re seeing?  The labor market is in disinflation of labor rather than an actual weakening of labor?

JT: I think so. And I think the dynamics this time around are a lot different, right? Companies these days don’t wake up and say, “oh, we need to get rid of labor.” It’s not like that because corporate balance sheets are really strong, and folks don’t want to get caught offsides with not enough roster depth if the economy reaccelerates.

A slowing labor economy offers a rationale for the Fed to ease, but if it is only slowing modestly, we need to ponder whether the correct course of action would be a sustained series of rate cuts or simply an easing stance.  The mindset appears to have shifted from the former to something approaching the latter.  Traders will be listening eagerly for clues as to which path seems more likely.

For starters, we still see greater likelihood being placed on another cut in December.  IBKR ForecastTrader shows an 87% probability that rates will NOT be set above 4.375% in December, implying 50 bp of cuts between now and then – i.e. 25bp at each of the next two meetings.  It will be fascinating to know if Chair Powell shares that enthusiasm, especially if there are political considerations about cutting rates before or after the inauguration of the new administration. 

We will also be listening intently to Powell’s read about upcoming changes in the political landscape.  Tariffs, tax cuts, deportations, and threats to the Fed’s independence have all been raised during the campaign.  Any or all of them could have an immense impact upon the future decision-making process for the FOMC.  It would be understandable if the Chair refrains from commenting about theoretical political ramifications, though it is likely to be a popular topic of questions at the press conference.

My view is that the Fed needn’t have rushed to cut rates in September, nor is there a pressing need to continue cuts.  Frankly, there is little real-world evidence that monetary policy is restrictive in practice.  There are few, if any, signs of credit market stress, stock markets are at all-time highs, and a 4.1% unemployment rate would have been considered full employment throughout much of recent American history.  Quantitative tightening (QT) has reduced the Fed’s balance sheet substantially, though it is far larger than its pre-covid levels.  And while it has reduced the market’s dependence upon reverse repos, it is not as though QT is causing any particular stress (see graphs below). 

Ultimately, the Powell Fed has shown little inclination to disappoint markets and a bias toward lower rates.  We’ll learn soon enough if that stance continues.

Source: Interactive Brokers

Source: New York Federal Reserve Bank