FOMC Preview: Rate Cut Is A 'No-Brainer' , But Today Will Not Be An Easy Day For The Fed, Nor For The Market

For Powell and the Fed, "another rate cut" on Wednesday is seemingly a straightforward decision. However, managing the specifics of the official statement and post-meeting communication appears more challenging than usual for the Fed as a whole-especially given the persistent absence of economic data due to the US government shutdown and the frequent internal "disruptions" caused by Stephen Miran, the "president's mouthpiece," within the committee.

The prevailing market view is that the Fed will approve a second 25-basis-point rate cut at its meeting on Wednesday local time. Simultaneously, policymakers are likely to debate several issues, including the future path of rate cuts, the challenge of potentially prolonged data scarcity, and when to end "quantitative tightening" (QT)-the reduction of its holdings of Treasury bonds and mortgage-backed securities (MBS).

Bill English, a Yale professor and former head of monetary affairs at the Fed, noted, They are at a moment in the policy cycle where there's genuine disagreement between people who are thinking we will probably cut rates but I'm not ready to cut again just yet, and people who think even though there's risks, it's time to do more now." He pointed out that some members see persistent risks warranting greater caution, while others believe it's time for further easing.

For instance, new Fed Governor Stephen Miran is expected to potentially advocate for a larger rate cut at this meeting, especially after he argued for a 50-basis-point cut during the September FOMC meeting. Conversely, regional Fed presidents like Beth Hammack (Cleveland), Lorie Logan (Dallas), and Jeffrey Schmid (St. Louis) are likely reluctant to commit to further cuts in December.

Therefore, Fed Chair Jerome Powell must once again navigate these divisions. Based on his recent remarks, which expressed concern about the state of the labor market, Powell is likely to strike a neutral tone in his post-meeting press conference: supporting an October cut but avoiding clear signals about a follow-up cut in December.

Could A "Weak Labor Market" Drive Sustained Rate Cuts?

The labor market is considered a key reason for the Fed initiating rate cuts in the second half of the year. US job growth weakened during the summer-according to Labor Department data, employers added an average of about 29,000 jobs per month over the three months leading up to August. Although this was slightly higher than July's figure, given that Q2's data was already the weakest quarterly growth since 2010, August's numbers weren't particularly optimistic.

Since the US federal government shutdown began on October 1st, the Bureau of Labor Statistics has not released September employment data. However, unemployment claims data up to September 6th shows initial claims rose to their highest level in nearly four years, and the number of people unemployed for over 26 weeks reached its highest since November 2021. All signs point to a US labor market becoming increasingly fragile.

Regarding this, Luke Tilley, Chief Economist at Wilmington Trust, stated that despite the lack of recent data, the currently evident poor state of the labor market might prompt the Fed to continue cutting rates into the future, potentially even extending into 2026. "We expect 25 [basis points] and then again in December, and then again in January and March and April," Tilley said.

However, Goldman Sachs economists believe the bar for a December rate cut is high, requiring sufficient justification from alternative data, which the currently available data hasn't provided.

Fed's View on Tariff-Inflation Might Shift

The Fed's stance on tariffs remains a focus for external observers. Trump's tariff policies have already contributed to rising inflation in recent months, but this time, Fed officials might be more inclined to view the inflationary impact as "transitory."

San Francisco Fed President Mary Daly previously wrote on social media, "tariff-related price increases will be a one-off." St. Louis Fed President Alberto Musalem also stated earlier this month that he expects "the effects of tariffs will work through the economy over the next two to three quarters and the impact on inflation will fade after that."

Fed Governor Waller, in a speech in Miami on August 28th, said, "Inflation has increased since the first quarter, but these numbers include the effects of import tariff increases, which, with inflation expectations anchored, I continue to expect will only temporarily raise inflation."

"Most forecasts are for 12-month inflation to continue to slowly increase for a couple more months, with monthly tariff effects dissipating by early 2026," Waller added.

Is Liquidity Relief Finally Coming?

Additionally, markets are closely watching for signals on when the Fed will stop reducing its $6.6 trillion balance sheet, primarily comprising Treasuries and MBS. Powell recently indicated that the quantitative tightening (QT) process is nearing its end. There is debate over whether the Fed will announce the end of the QT program or merely provide an end date. Tilley believes, "There are already slight signs of strain in short-term markets, so the Fed might announce that QT is concluding soon."

Another view suggests that even if the Fed doesn't explicitly halt QT at this meeting, the Committee should still provide liquidity support through a technical adjustment, such as lowering the Interest Rate on Reserve Balances (IORB).