When the Federal Reserve meets Wednesday, officials are expected to mark the end of an era as they cut interest rates for the first time in four years and chart a course for lower rates over the next two years.
“This is a big meeting,” said former Kansas City Fed president Esther George. “It’s one that’s been foreshadowed since late last year. It’s long been expected.”
The central bank is expected to lower rates by a quarter percentage point to a new range of 5.0-5.25% from its 23-year high of 5.25% to 5.5% on Wednesday when their policy meeting concludes. The actions will officially mark the termination of the most aggressive inflation-fighting campaign since the 1980s.
Investors bets on how deeply the Fed will cut rates for the first time have been fluctuating widely. As of Friday afternoon, traders were pricing in nearly 50-50 chance of the Fed trims its policy rate by 25 basis points verses a steeper 50 basis points. Those odds compare with an 85% chance for a 25 basis point cut on the back of key inflation and jobs data over the past week.
Read more: What the Fed rate decision means for bank accounts, CDs, loans, and credit cards
The Fed is set to cut rates roughly six weeks before the presidential election, something Republican presidential candidate and former President Trump and other Republicans have said the central bank should refrain from until after the election.
The rate cut will mark the first in a series of cuts, as the central bank’s new era of easy money is expected to last through 2025 and 2026. That shift will ripple through the US economy by making it cheaper for Americans to borrow what they need to buy houses and cars or credit card purchases.
Businesses will also have an easier time taking out loans to fund their operations.
Fed officials will release new interest rate projections, known as the “dot plot,” for how many rate cuts officials see in the remainder of this year and next.
Luke Tilley, veteran chief economist for Wilmington Trust, expects the Fed to cut by 25 basis points — and to lay out a path to cut twice more this year, also in 25 basis point increments, followed by cuts next year at six out of the Fed’s eight policy meetings. He added that if the Fed can cut rates by 50 basis points in subsequent meetings without spooking markets, it will.
Tilley believes the Fed is behind the curve when it comes to cutting rates because “there would be no talk of 50 right now if they had just started reducing in July and they were on a slower path.” Still, Tilley said, it doesn’t matter whether the Fed lowers rates by 75 basis points or 100 basis points overall this year.
“It’s more the trajectory, how they talk about it and how they frame it because their words count for more than their actions,” Tilley said, referencing markets pricing in future Fed actions.
As for ex-Kansas City Fed chief George, she at a minimum she expects a rate cut of 25 basis points every meeting for the rest of the year. (There are three, including Wednesday’s.)
She estimates the Fed will cut rates by 1.25 to 1.5 percentage points before they may pause and take stock of how the level on rates is relative to how the economy is faring. But the thing she’s really watching for is “this is a committee that will have to develop a narrative around the 50 basis point rate cut idea.”
Meanwhile, Fed governor Chris Waller has said that he’s open-minded about the size and pace of cuts based on the data — and if the data suggests the need for larger cuts, then he will support that. Waller said he was a big advocate of front-loading rate hikes when inflation accelerated in 2022, and he will be an advocate of front-loading rate cuts if that is appropriate.
The story behind the story
Officials are looking to cut rates, having gained confidence inflation is likely heading back down to their 2% target. The latest reading on inflation, measured by the Consumer Price Index, showed inflation continues to move down slowly, marking the fifth consecutive good inflation report. After fears inflation was stalling in the first quarter, officials had said they needed more than a quarter’s worth of good inflation data to gain confidence inflation was truly falling. Inflation, based on CPI, rose at 3.2% in August and July, compared with 3.3% in June, 3.4% in May, and 3.6% in April.
Read more: Cell phones, furniture, used cars: Here’s where prices are easing up as inflation cooldown continues
Inflation expectations are also dropping. The difference in the yield on a 10-year inflation-protected government bond and a standard bond of the same maturity, a measure of expected inflation, is around the lowest since early 2021. Inflation expectations over the next two years are for CPI inflation of just 1.5%, under the Fed’s 2% target.
Job watch
At the same time, the job market is cooling, as employment decelerated over the summer, with 118,000 jobs created in June, 89,000 in July, and 142,000 in August — all below the average monthly gain of 202,000 over the prior 12 months.
The weakening has caused Fed officials to turn more attention toward the labor market and away from inflation.
Fed Chair Jay Powell said in a speech in Jackson Hole, Wyo., in late August that the Fed “will do everything we can to support a strong labor market as we make further progress toward price stability.” He noted that the Fed does not “seek or welcome further cooling in labor market conditions” and that the current level of the policy rate gives the Fed “ample room” to lower rates in response to any weakening in the job market.
Fed watchers expect Powell to reiterate many of these messages communicated in Jackson Hole.
Predictions
On Wednesday, Fed officials will also release forecasts for unemployment, inflation, and the economic outlook. Powell will hold a press conference at 2:30 p.m. ET.
George said she sees a couple of scenarios, including one where Powell could set the stage for cutting by larger increments. “He could tell a story around 50,” said George. “He could come out at this meeting and say, ‘We’ll move more aggressively to make sure we do our part around the labor market.'”
But Wilmer Stith, bond fund manager for Wilmington Trust, said, “I think Powell plays it right down the middle.” Stith added that the Fed is very conscientious of the pain associated with a higher unemployment rate, but also conscientious of the cost of living for the average American.
EY’s chief economist Gregory Daco also agreed that “gradualism” will prevail at the meeting, but said that there may be a reference to larger rate cuts at upcoming meetings.
Are recession fears still looming? There was concern at the July jobs report that the economy had entered recession, but a rebound in the August jobs tally allayed concerns.
Wilmington Trust’s Tilley expects the job market to continue expanding.
“We do not think the labor market is rolling over into a recession. That said, it is the biggest concern,” he said.
Tilley still believes the soft landing is in place, but said, “The economy is slowing and is vulnerable to a shock.”
And it wouldn’t necessarily take a big disturbance. Tilley’s examples: a big oil shock that could hurt consumer spending or a plunge in the stock market that could cause businesses to pull back on hiring. He also said some policies of presidential candidates Donald Trump and Kamala Harris — like tariffs across the board or tax hikes — could end up hitting the consumer next year.
Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance she covers the Federal Reserve, cryptocurrencies, and the intersection of business and politics. Follow her on X @Jenniferisms.
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