WASHINGTON — No one knows how Tuesday’s presidential election will turn out, but the Federal Reserve’s action two days later is much easier to predict: continues to coolthe Fed plans to lower interest rates for a period of time second time this year.
The presidential battle could still be unresolved when the Fed ends its two-day meeting Thursday afternoon, but that uncertainty would have no effect on its decision to further cut its benchmark rate. However, the Fed’s future actions will become more uncertain once a new president and Congress take office in January, especially if Donald Trump were to win the White House again.
Trump’s proposals to impose high tariffs on all imports and launch mass deportations of unauthorized immigrants, and his threat to encroach on the Fed’s normally independent interest rate decisions, could push inflation higher, economists say. Higher inflation would, in turn, force the Fed to slow or halt its interest rate cuts.
On Thursday, Fed policymakers, led by Chairman Jerome Powell, are on track to cut their benchmark interest rate by a quarter point to about 4.6%, after cutting it by a half point in September. Economists expect another quarter-point rate cut in December and possibly more such cuts next year. Over time, interest rate cuts tend to lower the cost of borrowing for consumers and businesses.
The Fed lowers its interest rates for a different reason than usual: it often lowers rates to stimulate a sluggish economy and weak labor market by encouraging more borrowing and spending. But the economy is growing stronglyand so is the unemployment rate a low 4.1%the government reported on Friday, even with hurricanes and a strike at Boeing sharply depressed net job growth last month.
Instead, the central bank is cutting rates as part of what Powell has called “a recalibration” toward a lower inflation environment. When inflation spiked to a four-decade high of 9.1% in June 2022, the Fed moved to raise rates 11 times – ultimately sending the key rate to around 5.3%, also the highest in four decades.
But in September, inflation was at an annual rate dropped to 2.4%barely above the Fed’s 2% target and equal to 2018 levels. With inflation down so far, Powell and other Fed officials have said they think high interest rates are no longer necessary. High interest rates tend to limit 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 has disappeared.”
Fed officials have suggested that their rate cuts would be gradual. But almost all have expressed support for further reductions.
“For me, the key question is how much and how quickly we should reduce the target for the (key) interest rate, which in my view is currently set at a restrictive level,” said Christopher Waller, an influential member of the Board of Directors of the Fed. said in a speech last month.
Jonathan Pingle, an economist at Swiss bank UBS, said Waller’s formulation reflected “unusual confidence and belief that interest rates were going down.”
Next year, the Fed will likely begin wrestling with exactly how low benchmark rates should go. Ultimately, they may want to set it at a level that neither limits nor stimulates growth – “neutral” in the Fed’s jargon.
Powell and other Fed officials acknowledge they don’t know exactly where the neutral rate is. In September, the Fed’s interest rate setting committee estimated this rate at 2.9%. Most economists think it is closer to 3% to 3.5%.
The Fed chairman said officials should judge where neutral is based on how the economy responds to rate cuts. For now, most officials are confident that the Fed’s current rate is well above neutral at 4.9%.
However, some economists argue that with the economy looking healthy even with high interest rates, the Fed doesn’t need to ease lending much, if at all. The idea is that they may already be close to the interest rate level that neither slows nor stimulates the economy.
“If the unemployment rate remains in the low 40s and the economy is still going to grow at 3%, does it matter that the (Fed) rate is 4.75% to 5%?” wondered Joe LaVorgna, chief economist at SMBC Nikko Securities. “Why are they cutting now?”
With the Fed’s final meeting coming just after Election Day, Powell is likely to answer questions at his press conference on Thursday about the outcome of the presidential race and how it could affect the economy and inflation. He can be expected to reiterate 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 range of goods from China, which President Joe Biden maintained. Although research shows that washing machine prices rose as a result, overall inflation did not rise much.
But Trump is now proposing significantly broader tariffs — essentially import taxes — that would raise the prices of about ten times as many goods from abroad.
Many mainstream economists are alarmed by Trump’s latest proposed tariffs, which they say would almost certainly fuel inflation. A report from the Peterson Institute for International Economics concluded that the most important tariff proposals are Trump’s would make inflation 2 percentage points higher next year than it otherwise would have been.
According to economists at Pantheon Macroeconomics, it would be more likely that the Fed would raise rates in response to the tariffs, “as Trump threatens much larger rate hikes.”
“Accordingly,” they wrote, “we will scale back the fund rate cut in our 2025 forecasts if Trump wins.”