Fed policymakers began cutting rates in September with a 0.5% cut, and last week they cut again by 0.25%. The Fed has signaled it is ready to cut rates further as long as inflation continues to slow. Many favor a gradual approach to future rate cuts.
"The Fed has tightened more than it needs to at this point," said Lindsey Piegza, chief economist at Stifel Financial Corp., who predicts a pause in January, followed by up to three cuts next year.
Fed Chairman Jerome Powell's comments prompted traders to reduce expectations for a rate cut in December. In addition, with the yield on the benchmark 2-year Treasury note rising 8 basis points to 4.36% on Thursday, swap traders also reduced the probability of the Fed cutting rates at its next meeting ending on December 18 to below 60%.
In a discussion after his speech, Powell said he was uncertain about the neutral interest rate, where monetary policy neither stimulates nor slows economic growth, which is why the Fed is proceeding cautiously. Some Fed officials believe the federal funds rate remains restrictive and favor a gradual reduction.
Data released earlier this week showed a measure of core US inflation remained elevated in October. The core consumer price index - which excludes food and energy costs - rose 0.3% for the third straight month.
With employment in balance and inflation expectations well under control, the Fed Chairman expects inflation to continue to decline gradually toward the 2% target, although the path may be difficult.
However, Powell did not make any comments on the possibility of a rate cut at the December meeting.
Monetary policy could face challenges next year if President-elect Donald Trump delivers on campaign promises to cut taxes, curb immigration and impose tariffs. Policy uncertainty may also be a factor in the Fed’s current cautious stance on cutting interest rates.
It is too early for policymakers to make any changes to anticipate new fiscal or trade policies.
The US economy continues to expand at a robust pace, averaging 3% growth over the past two years. Meanwhile, the labour market is in “solid shape” and by many measures has now returned to “more normal” levels consistent with the task of achieving maximum employment.
Improved supply conditions have supported the economy’s strong performance, with the labor force expanding rapidly and productivity rising faster over the past five years than in the two decades before the pandemic, increasing the economy’s productive capacity and allowing for rapid economic growth without overheating.
Higher productivity, which allows workers to produce more per hour, helps control inflation and is key to long-term economic growth.
Some policymakers, including Neel Kashkari of the Minneapolis Fed, argue that higher yields could lead to fewer rate cuts.
Thus, the path of policy rates will depend on upcoming economic data and outlook.
The Fed chairman also offered his clearest comments yet on the central bank's upcoming review of its policy framework.
Questions raised in the review will revolve around how concerned policymakers are about the current floor on interest rates, which are likely to remain higher than before the pandemic, he said.
Since 2008, officials have cut the key interest rate to zero twice, limiting the effectiveness of monetary policy.
The Fed has yet to make a decision, and the central bank will switch to a traditional inflation target. The current framework, released in 2020, sees policymakers pursuing a period of overshooting the Fed’s 2% target as price increases continue to run below target.
