Fed's Rate Cut Outlook Fractured by Inflation Woes and Labor Market Divides

The Federal Reserve's probability of a 25 basis point interest rate cut in December has dipped to 63%, down from near-certainty earlier this week, as traders recalibrated their expectations following mixed signals from policymakers and economic data, as Dallas Fed's Logan said. This shift reflects growing uncertainty over the Fed's future path, with dissenting voices within the central bank and unresolved labor market concerns complicating the outlook.

The Fed's recent decision to cut rates by 25 bps in October, announced on October 30, was met with internal divisions. Stephen Miran, a newly appointed governor, dissented in favor of a larger 50 bps cut, aligning with President Donald Trump's calls for aggressive easing. Conversely, Kansas City Fed President Jeffrey Schmid opposed the move, arguing that labor market weakness is likely structural rather than cyclical and that the cut could undermine inflation control, according to the New York Times. This marks the first split dissent since 2019, highlighting a fractured policy outlook.

Market participants had initially priced in a 95% chance of a December rate cut, but that has since fallen to 63% as Fed officials signaled caution. Chair Jerome Powell emphasized during a press conference that the December decision would hinge on incoming data, particularly employment trends, which have been obscured by the ongoing government shutdown. Key metrics like the September jobs report and weekly jobless claims remain delayed, forcing the Fed to rely on incomplete information, according to FXStreet. Powell also acknowledged rising inflation risks, noting that core CPI rose 0.3% in September, above expectations, as reported by Wealth Professional.

The labor market's mixed signals have further muddied the waters. While aggregate unemployment remains low, demographic data shows rising joblessness among Black workers. Powell conceded that the Fed's tools cannot target specific groups, underscoring the challenge of balancing inflation control with equitable labor outcomes, as reported by the New York Times. Meanwhile, Cleveland Fed President Beth Hammack and Dallas Fed President Lorie Logan joined the chorus of hawks, with Hammack stating she would have preferred to hold rates steady at the October meeting to preserve inflation-fighting momentum, according to Bloomberg.

Despite these internal debates, the market's dovish bias persists. The CME FedWatch tool still shows a 63% probability of a December cut, with analysts like TD Securities noting the Fed is likely to adopt a "tilt dovish" stance amid weak labor data, according to FXStreet. However, Dallas Fed President Logan pushed back, arguing that stubborn inflation justifies a pause, stating, "A further reduction in the policy rate at the December meeting is not a forgone conclusion—far from it," as Dallas Fed's Logan said.

The government shutdown has added another layer of complexity. With federal workers unpaid for over six weeks, the economic toll could force the Fed to act preemptively, though Powell warned that data gaps might limit the effectiveness of policy adjustments, according to FXStreet. The Fed's next steps will be closely watched as it navigates a fragile equilibrium between inflation risks and labor market vulnerabilities.