Federal Reserve is set to cut rates again while facing a hazy post-election outlook

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WASHINGTON (AP) — No one knows how the presidential election will turn out Tuesday, but it’s easier to predict the Fed’s move two days later: With inflation still low, the Fed is set to cut interest rates for the second time this year. .

The presidential contest may remain unresolved when the Federal Reserve ends its two-day meeting on Thursday afternoon, but this uncertainty will have no impact on its decision to further cut its benchmark interest rate. However, the Fed’s future actions will become more erratic once a new president and Congress take office in January, especially if Donald Trump wins the White House again.

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Economists say Trump’s proposals to impose high tariffs on all imports, launch mass deportations of unauthorized immigrants and his threat to interfere in the Fed’s usually independent decisions on interest rates could lead to higher inflation. Higher inflation, in turn, would force the Fed to slow or halt interest rate cuts.

On Thursday, Federal Reserve policymakers, led by Chairman Jerome Powell, are on track to cut the benchmark interest rate by a quarter of a percentage point, to about 4.6%, after implementing a half-point cut in September. Economists expect another quarter-point rate cut in December and possibly additional such moves next year. Over time, interest rate cuts tend to lower borrowing costs for consumers and businesses.

The Fed cuts interest rates for a different reason than it normally does: It often lowers interest rates to bolster a sluggish economy and weak labor market by encouraging more borrowing and spending. But the economy is growing quickly, and the unemployment rate is low at 4.1%, the government said Friday, even as hurricanes and a strike at Boeing led to a sharp decline in net job growth last month.

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Instead, the central bank is cutting interest rates as part of what Powell called a “recalibration” to a low-inflation environment. When inflation rose to a four-decade high of 9.1% in June 2022, the Fed proceeded to raise interest rates 11 times – ultimately raising the key interest rate to around 5.3%, also the highest level in four years. Contracts.

But in September, year-over-year inflation fell to 2.4%, barely above the Fed’s 2% target and equal to its level in 2018. With inflation so far lower, Powell and other Fed officials said they believe borrowing rates will High is no longer necessary. High borrowing rates typically constrain growth, especially in interest rate-sensitive sectors such as housing and car sales.

“The restriction was in place because inflation was high,” said Claudia Sahm, chief economist at New Century Advisors and a former Fed economist. “Inflation is no longer high. The reason for the restriction is gone.”

Fed officials have indicated that interest rate cuts will be gradual. But almost all of them expressed support for further cuts.

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“For me, the key question is how far and how quickly the target will be cut for the (Fed’s key) interest rate, which I believe is currently set at a constrained level,” said Christopher Waller, an influential member of the Fed’s board. he said in a speech last month.

Waller’s formulation reflects “extraordinary confidence and conviction that interest rates are heading lower,” said Jonathan Bingel, an economist at Swiss bank UBS.

Next year, the Fed will likely begin to wrestle with the question of how low its benchmark interest rate should go. Ultimately, they may want to set it at a level that neither restricts nor stimulates growth — “neutral” in the Fed’s parlance.

Powell and other Fed officials admit they don’t know exactly where the neutral rate lies. In September, the Federal Reserve’s rate-setting committee estimated it would reach 2.9%. Most economists think it’s closer to 3% to 3.5%.

The Fed chairman said officials should assess how neutral they are by how the economy responds to interest rate cuts. Currently, most officials are confident that the current interest rate imposed by the Federal Reserve, at 4.9%, is well above the neutral level.

However, some economists argue that with the economy looking healthy even as borrowing rates rise, the Fed does not need to ease credit much, if at all. The idea is that they may already be close to the level of interest rates that neither slows nor stimulates the economy.

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“If the unemployment rate stays at low 4 and the economy continues to grow at 3%, does it matter if the (Federal Reserve) interest rate is between 4.75% and 5%?” asked Joe LaVorgna, chief economist at SMBC Nikko Securities. “Why are they cutting now?”

With the Fed’s latest meeting taking place right after Election Day, Powell is likely to ask questions at his Thursday news conference about the outcome of the presidential race and how it could affect the economy and inflation. He is expected to reaffirm that the Fed’s decisions are not influenced by politics at all.

During Trump’s presidency, he imposed tariffs on washing machines, solar panels, steel and a host of goods coming from China, which President Joe Biden maintained. Although studies indicate that washing machine prices rose as a result, overall inflation did not increase much.

But Trump is now proposing broader tariffs — essentially taxes on imports — that would raise prices about tenfold on goods coming from abroad.

Many major economists are concerned about Trump’s latest proposed tariffs, which they say are certain to reignite inflation. A report from the Peterson Institute for International Economics concluded that Trump’s major tariff proposals would make inflation 2 percentage points higher next year than it otherwise would have been.

The Fed is more likely to raise interest rates in response to the tariffs this time around, according to economists at Pantheon Macroeconomics, “given that Trump is threatening much larger tariff increases.”

“Accordingly, we will reduce the funds rate cut in our 2025 forecast if Trump wins,” they wrote.

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