Fed's Shifting Course on Interest Rates

Federal Reserve Chair Jerome Powell finds himself navigating a complex landscape as he prepares for the central bank's potential interest rate cut this week. Following two consecutive rate reductions in September and November, Powell faces internal dissent and a fluctuating economic outlook that necessitate a careful approach.

"Right now, either a cut or a hold could be justified," says Jon Faust, former senior advisor to Powell, to the Wall Street Journal. However, he emphasizes that "what officials say about the path of the fed-funds rate is likely to be more important than whatever they decide about the December meeting in particular."

The Fed's decision will be closely watched, given the Fed funds rate's influence on borrowing costs across the economy. While the first two cuts were intended to stimulate growth, some officials now question the need for further reductions, particularly given recent data suggesting a resilient labor market and potentially firmer inflation.

"If I were sitting on the committee right now as a voting member, I would dissent against a cut," says Eric Rosengren, former Boston Fed president, to the WSJ. He echoes the sentiment of several "hawkish" officials who fear that continued cuts risk undermining the Fed's credibility and allowing inflation to remain above its target for an extended period.

This concern is further amplified by uncertainty surrounding the incoming Trump administration's potential policies on immigration and trade, which could impact wage growth and consumer prices.

"Given recent economic activity, it's hard to think that the level of interest rates is restrictive at this point," says Fed Governor Michelle Bowman, in a speech this month, highlighting the need for caution in cutting too far.

Dallas Fed President Lorie Logan warns against excessive cuts, comparing the situation to a ship captain who might mistake mud for water on a depth finder. She cautions that the current low interest rates might not be the truly optimal level for the economy.

Despite these concerns, Powell maintains that the Fed must remain flexible. "We're mindful of the risk that we go too far, too fast, but also of the risk that we don't go far enough," he stated last month.

While the labor market has shown resilience, with over 140,000 jobs added per month on average for the past six months, the unemployment rate has ticked up to 4.2%, suggesting a potential moderation in hiring.

The Fed's internal discussions are often characterized by diverse viewpoints. Following a series of encouraging inflation reports last year, several officials who had initially opposed rate cuts began to shift their stance. However, the current economic landscape, characterized by fluctuating inflation and potential policy changes under the new administration, has once again created uncertainty.

"The first time you change direction, it takes on perhaps more importance than it should," says Faust. "People take it as a signal of the all-clear being given."

In September, Powell's decision to initiate a larger-than-expected half-point cut came after a period of internal debate. The move was driven by concerns that a smaller cut might be insufficient if the economy began to slow more sharply than anticipated.