The Fed has been waiting for four years to cut interest rates. But the decision is still difficult

Washington
CNN
—

The Federal Reserve is widely expected to announce a rate cut on Wednesday, the first such move in more than four years.

Regardless of whether the central bank cuts borrowing costs by a whopping half a percentage point, as expected, or, more typically, by a quarter of a percentage point, the decision would be a critical turning point for the U.S. economy – and for consumers, who are currently struggling with the highest costs in decades.

It is also a sign that Fed officials are confident that inflation is just under control enough to allow them to ease their monetary policy.

However, this is not a declaration of victory over inflation, but rather a cautious balancing act that draws more attention to the American labor market, which has shown signs of weakness.

While the central bank has signaled in recent weeks that it is willing to lower borrowing costs, calls for a half-percentage-point rate cut have grown louder in recent days. Typically, Wall Street and economists agree on what to expect ahead of a Fed decision on interest rate policy. But investor bets on a half-percentage-point cut rose on Monday; and by Tuesday afternoon, federal funds futures were pricing in a 63% probability of a jumbo rate cut, according to CME Group, up from around 30% on Thursday.

A number of prominent economists and politicians have also urged a bold move this week. Fed Chairman Christopher Waller, a key ambassador for the central bank’s policy moves, said earlier this month: “The current data no longer requires patience, but action.” On Monday, Senator Elizabeth Warren and two Democratic colleagues called for a three-quarter percentage point cut, saying the Fed’s “delay” was damaging the labor market.

On Tuesday, former Dallas Fed President Robert Kaplan said in an interview with CNBC that the Fed “might be late for a meeting or something” and said he would support a half-basis-point cut. Former New York Fed President Bill Dudley said in an opinion piece in Bloomberg that “the logic supporting a 50 basis-point cut is compelling.”

Still, the Fed has historically acted prudently, making its interest rate decisions in line with economic developments. Signs of an upturn are plentiful. New jobless claims remain at historic lows, American shoppers continue to open their wallets, the Dow Jones and S&P hit new highs this week, and the unemployment rate, while up, remains low by historical standards.

“Despite Fed Chairman Powell and Governor Waller’s openness to bringing forward rate cuts, we expect the ‘gradual approach’ to prevail,” Gregory Daco, chief economist at EY-Parthenon, said in a note last week. “We believe policymakers will reach consensus on a (quarter-percent) rate cut.”

For years, inflation was the center of attention and captured the attention of Fed officials and investors. Now that is no longer the case.

That honor now goes to the Labor Department’s monthly employment report, which includes data on monthly wage growth, wage gains, and unemployment. As inflation soared in 2021 and 2022, American employers created jobs and the unemployment rate fell to its lowest level in half a century. The Fed finally responded to the country’s inflation problem with its bitter medicine of high interest rates.

The Fed has made some encouraging progress since launching its historic inflation-fighting campaign in March 2022: The Fed’s favorite inflation indicator – the personal consumption expenditures price index – recorded an annual rate of 2.5% in July, a significant decline from the four-decade high of 7.1% in June 2022. This is within reach of the Fed’s official 2% target, and despite some persistence in elevated housing costs, economists expect inflation to fall over the course of the year.

But as the Fed’s rate hikes cool the economy and dampen inflation, they have also likely helped revive the labor market, which was expected to return to normal after its post-pandemic peak. Monthly job growth has slowed in recent months, and the government announced the biggest downward revision to its official employment data since 2009. There were 818,000 fewer jobs in the year through March than originally reported.

“We don’t see any systemic employment concerns at large companies yet, especially because we have a stable earnings environment that doesn’t point to looming mass layoffs,” Julia Hermann, global market strategist at New York Life Investments, told CNN.

“However, the other half of private jobs in the US come from small businesses, and they don’t believe now is a good time to expand. So overall we are seeing cracks on the surface of the labor market.”