WSJ Timiraos Weighs Fed's Crucial Decision: Start Small or Go Big?
3min read As the Federal Open Market Committee (FOMC) prepares for its next meeting, the focus of market participants, economists, and investors alike centers around the size of the expected rate cut. The debate has intensified following recent economic data, which presents a complex backdrop for the Federal Reserve to consider.
The question is whether to implement a traditional 25 basis point (bp) cut or opt for a more substantial 50 bp reduction.
Diverse Economic Signals Complicate the Fed's Decision
Recent economic indicators have provided mixed signals, making the Fed's upcoming decision more challenging. On one hand, the Consumer Price Index (CPI) report released this week showed firmer housing costs, which might deter a more aggressive rate cut.
Shelter inflation rose by 0.5 percent month-over-month in August, contributing to an annual increase that is still above the Fed's 2 percent inflation target.
This strengthens the case for a more cautious approach, opting for a smaller cut to avoid over-stimulating an economy where certain inflationary pressures remain.
Conversely, labor market dynamics have evolved, adding to the complexity. Although hiring data for June and July were weaker than initially reported, August showed a modest improvement in payroll growth.
This trend indicates that the labor market is not deteriorating as sharply as some had feared. Nevertheless, weaker hiring data over the summer may have created room for the Fed to act more decisively to support economic growth and employment, particularly if they are concerned about maintaining higher rates for too long.
The Tactical Debate: 25 bp or 50 bp?
Federal Reserve Chair Jerome Powell has maintained a position of flexibility, keeping all options on the table as the central bank grapples with determining the most prudent path forward. A key factor influencing the rate cut decision will be the Fed's assessment of how its actions might impact broader economic conditions over the coming months.
Jon Faust, a former senior adviser to Powell, highlights that the real significance lies not in the initial move—whether 25 bp or 50 bp—but rather in the overall trajectory of cuts in the months ahead.
Currently, market sentiment leans towards a 25 bp cut, given the recent economic data and the Fed's historical tendency toward incremental policy changes.
A smaller cut would signal a cautious approach, allowing the Fed to gauge the impact on inflation and economic growth without committing to a more aggressive easing path prematurely.
However, forecasts for a 50 bp cut remain in play. Advocates of a larger cut argue that such a move could provide a stronger signal of the Fed's commitment to supporting economic growth in a period of heightened uncertainty.
With global economic pressures, including a slowing Chinese economy and geopolitical tensions, there is a case to be made for taking more robust action to buffer the U.S. economy against external shocks.
Navigating the Broader Strategy
Beyond the tactical decision of the initial rate cut, the Fed's broader strategy will likely involve a series of calculated moves designed to balance risks on multiple fronts. On one side is the risk of doing too little and allowing economic momentum to falter; on the other is the risk of doing too much and reigniting inflationary pressures that the Fed has worked hard to contain.
In this context, Powell and his colleagues may prioritize a series of smaller, more predictable cuts that provide flexibility to adjust as more data becomes available. This strategy would keep market expectations anchored and avoid the potential overreaction that could follow a larger-than-expected initial cut.
Moreover, the Fed's caution is not without reason. The impact of rate cuts on financial conditions can vary, and a larger cut might not produce the desired economic stimulus, especially if market participants interpret it as a sign of panic or over-concern about the economic outlook.
Conclusion: A Delicate Balancing Act
As the FOMC meeting approaches, the decision on whether to opt for a 25 bp or 50 bp rate cut remains finely balanced. The Fed faces the challenging task of navigating a complex economic landscape with competing signals.
While a 25 bp cut appears to be the more likely choice given current market conditions and economic data, the door remains open for a bolder move if the Fed deems it necessary to shore up economic growth and counterbalance downside risks.
Ultimately, the decision will offer clues about the Fed's broader strategy and its tolerance for risk in the pursuit of its dual mandate of maximum employment and price stability. As such, all eyes will be on Powell and the FOMC next week, as they provide critical guidance on the path ahead for U.S. monetary policy.