Why hopes of a December Fed rate cut are declining

Key Concepts

• Federal Reserve (Fed) Policy: The actions taken by the U.S. central bank to manage monetary policy, primarily through interest rates and the money supply.
• Interest Rate Cuts: A reduction in the target federal funds rate, intended to stimulate economic activity by making borrowing cheaper.
• Inflation: A general increase in prices and a fall in the purchasing value of money. The Fed's primary objective is to maintain price stability, typically targeting a 2% inflation rate.
• FOMC (Federal Open Market Committee): The body within the Federal Reserve System that directs monetary policy.
• Hawkish vs. Dovish Stance: "Hawkish" refers to a monetary policy stance that favors higher interest rates to combat inflation, while "dovish" favors lower interest rates to stimulate economic growth.
• Structural Issues: Long-term, fundamental problems in the economy, such as those related to technology or immigration, that are not easily addressed by short-term monetary policy adjustments.
• Dissent: When a member of the FOMC disagrees with the majority decision on a policy action.
• Regional Fed Bank Presidents: Leaders of the 12 regional Federal Reserve Banks, some of whom vote on FOMC decisions in a rotating manner.
• Nomination and Succession: The process by which the President appoints individuals to key positions within the Federal Reserve, including the Chair.

Future of Fed Policy and December Rate Cut Prospects

The primary focus for investors is the future direction of Federal Reserve policy, specifically the likelihood of an interest rate cut at the Fed's final meeting of the year, which is approximately one month away.

• Increasing Doubt on December Rate Cut: Yahoo Finance's Fed correspondent, Jennifer Shawnberger, reports that a rate cut in December is becoming increasingly doubtful. This sentiment is driven by a growing number of Fed officials expressing caution about further rate reductions.
• Kansas City Fed President Jeff Schmid's Stance: Jeff Schmid, President of the Kansas City Fed, is the latest official to voice his belief that inflation remains too high. He suggested that at the December meeting, there is a possibility of holding rates steady. Schmid had previously dissented at the last policy meeting, also preferring to hold rates steady.
• Schmid's Rationale for Dissent: Schmid does not believe that further rate cuts would effectively boost the job market. He views the current stresses in the job market as more structural and long-term issues, citing factors like technology and changes in immigration policy. He stated, "rate cuts could have longer-lasting effects on inflation as our commitment to our 2% objective increasingly comes into question." He reiterated this as his rationale for dissenting against a rate cut at the last meeting and one that continues to guide his thoughts for the December meeting.

Internal Division within the Fed

Schmid's comments highlight a growing divide within the Federal Reserve, with an increasing number of officials leaning towards holding rates steady.

• Redrawing Expectations: A chart illustrates how the median expectation for three rate cuts this year has been significantly revised.
• Key Officials' Positions:
  • Undecided but Leaning Against Cuts: Boston Fed's Collins, St. Louis's Malum, and Kansas City's Schmid.
  • Chicago's Goulsby: Previously stated that the bar for cutting rates is much higher due to inflation trending in the wrong direction.
  • In Favor of Rate Cuts: Waller, Myron, and Bowman.
  • Undecided/Could Go Either Way: Including Fed Chair Powell.
• Projected Dissents: Regardless of the decision, it is anticipated that there will be dissents. If the Fed decides to cut rates, three to four dissents are possible. If the Fed decides to hold steady, there is a potential for three dissents.

Market Expectations for a December Rate Cut

Trader sentiment and pricing reflect the diminishing odds of a December rate cut.

• Dwindling Odds: The chances of a December rate cut have fallen to about 45%, a significant drop from approximately 94% a month ago. Earlier in the day, these odds were as low as nearly 40%.
• Fed Chair Powell's Statement: Fed Chair Powell previously indicated to the markets that a December rate cut was "not a foregone conclusion," and in fact, "far from it."

Potential Reshaping of the Fed in the Coming Year

Several factors could influence the composition and direction of the Federal Reserve in the next year, potentially reshaping its policy stance.

• Atlanta Fed President Rafael Bostic's Retirement: Atlanta Fed President Rafael Bostic will be retiring early next year, creating an opportunity for the President to reshape the Fed. His term was set to expire in February, and he had penciled in only one rate cut for the current year.
• Influence of New Appointments: The board of the Atlanta Fed will decide on Bostic's replacement, which could potentially shift the direction of that regional bank. Although the Atlanta Fed does not have a vote on the FOMC until 2027, its influence on the committee's direction is still possible.
• Succession of Fed Chair Powell: The President will also nominate a successor for Fed Chair Powell when his term ends in May. It is suggested that the President is seeking a nominee with a dovish position, which would significantly influence the committee.
• Supreme Court Ruling on Lisa Cook's Authority: A Supreme Court ruling in January regarding the President's authority to fire Fed Governor Lisa Cook could lead to another potential opening for the President to appoint a more dovish member if the ruling favors the President.
• Rotation of Regional Fed Bank Members: Four regional Fed bank members rotate off the FOMC each year, and four will rotate on next year. The incoming members are noted to have a hawkish outlook, suggesting the Fed could remain divided.

Conclusion

The current outlook indicates a strong possibility that the Federal Reserve will hold interest rates steady at its December meeting, contrary to earlier expectations of rate cuts. This shift is driven by concerns over persistent inflation and a growing number of Fed officials advocating for a cautious approach. Furthermore, upcoming changes in leadership and the composition of the FOMC, influenced by presidential nominations and potential Supreme Court rulings, suggest that the Fed's policy direction in the coming year remains subject to significant uncertainty and potential shifts in its hawkish or dovish leanings.