The Federal Reserve is poised to lower interest rates next week, marking the first rate cut in a long time. However, expectations for this move are tempered, with predictions pointing towards a gradual and measured easing cycle.
A mild easing cycle predicted
According to Fitch Ratings, the upcoming rate cut is expected to be modest, beginning with a 25-basis-point reduction, followed by another 25-basis-point cut in December. The Federal Reserve appears set to maintain a slow yet consistent pace, with further reductions anticipated over the next few years. Projections include 125 basis points in 2025 and 75 basis points in 2026, amounting to a cumulative 250 basis points spread across ten cuts over 25 months.
This cautious approach contrasts sharply with previous easing cycles, where the median decline from peak to trough was 470 basis points. The Federal Reserve’s current strategy reflects a more conservative stance, likely driven by ongoing concerns about inflation.
Inflation remains a key factor
Inflation plays a significant role in the Federal Reserve’s cautious approach. Despite a notable decrease in inflation, it remains above the Fed’s target of 2%. The consumer price index (CPI) is still higher than desired, with core inflation, excluding volatile components like food and energy, showing mixed signals.
In August, the CPI rose 2.5% year-over-year, slightly below expectations. However, core CPI remained at 3.2% over the past 12 months, with a slight uptick in month-to-month inflation. This persistent inflationary pressure underscores the Federal Reserve’s careful approach to rate cuts to avoid repeating past mistakes in controlling inflation.
Federal Reserve Officials Weigh In
Federal Reserve Chairman Jerome Powell and his colleagues are keenly aware of the challenges posed by inflation. The scars from their prolonged battle with inflation have made them cautious about aggressive policy moves. The possibility of a half-point cut has been discussed, but many, including former Cleveland Fed President Loretta Mester, argue that a gradual approach is more prudent.
Economists like Krishna Guha of Evercore ISI and Donald Kohn, former Fed Vice-Chair, emphasize the importance of flexibility in the Fed’s strategy. While the initial cuts may be modest, the Federal Reserve remains prepared to adjust its policy if inflationary pressures resurface.
Global implications of the Fed’s actions
The Federal Reserve’s actions will have global repercussions. In China, for instance, the People’s Bank of China has already lowered rates, and further cuts may follow as the U.S. dollar weakens. China’s economic challenges, including deflationary pressures, are prompting adjustments to their monetary policy.
Japan’s central bank is moving in the opposite direction, raising rates to combat persistent deflation. The Bank of Japan’s hawkish stance risks global markets, including stocks and cryptocurrencies.
In Europe, the European Central Bank recently cut rates, which led to a slight boost in regional stocks. The international landscape is changing, and the Federal Reserve’s cautious approach reflects the complexities of today’s global economy.