"Federal Reserve's Mouthpiece": The Federal Reserve is ready to cut interest rates, but faces four major issues

The following content comes from Nick Timiraos, a renowned journalist known as the "New Federal Reserve News Agency" and "Federal Reserve Mouthpiece" of The Wall Street Journal. The market expects the Federal Reserve to lower interest rates by 25 basis points at the meeting ending this week. But the bigger question is how much further the Federal Reserve officials expect to lower rates to maintain a robust labor market while keeping inflation on a downward trend. Officials find it difficult to provide a clear answer to this question, as their responses would be variations of: it depends on the situation. This week's decision lacks the suspense of the last meeting, when the market was uncertain about the extent of the Federal Reserve's rate cut. This means that Federal Reserve Chairman Jerome Powell's press conference this week will be a major event. Powell may try to avoid drawing attention after the election and refrain from answering questions about hot policy issues. The Federal Reserve strives to maintain political neutrality, and officials have postponed the meeting by a day to allow more space between the interest rate decision and the presidential election. In September's meeting, the Federal Reserve cut rates by 50 basis points, marking the first rate cut in four years. At this meeting, 19 participants were largely in agreement on whether to cut rates once or twice more this year. Nine expected a maximum of one more cut this year, while ten expected two cuts. The Federal Reserve will also hold a meeting in December this year. Investors will closely watch for any signals regarding the threshold for another rate cut in December. Richard Clarida, who served as Vice Chairman of the Federal Reserve from 2018 to early 2022, stated that the likelihood of another rate cut at the December meeting seems greater, but it is not a certainty. He noted that the outlook for 2025 is particularly uncertain. Here is an analysis of four questions officials face, which illustrate why the Federal Reserve's ability to provide meaningful interest rate guidance may be more limited: First, will the election results lead to significant changes in economic demand or inflation, necessitating a different policy path? Officials will not change their policy stance until they see what actions the elected President Trump takes regarding tax, tariff, and immigration reforms. However, if the Republican Party also gains control of both houses of Congress, the Federal Reserve's economists may begin to revise some of their fundamental assumptions at the December meeting. Records from the Federal Reserve's policy meeting in December 2016 show that officials and economists had intense debates on how to simulate the potential impact of tax cuts. Trump had just won the election with a majority in both houses of Congress. At that time, the Federal Reserve was gradually raising rates from very low levels. Second, are concerns about a deterioration in the labor market exaggerated? When the Federal Reserve cut rates in September, the unemployment rate rose from 3.7% at the beginning of the year to 4.3% in July. Job growth also slowed. Some economists worry that the Federal Reserve may keep rates too high for too long, leading to unnecessary weakness in the labor market. This concern is amplified by a rule of thumb that states once the unemployment rate begins to rise slightly, it usually rises more significantly Since the last meeting of officials, these concerns have eased somewhat, but they have not been completely eliminated. Employment growth rebounded in September but was very weak in October, which may reflect the impact of hurricanes and strikes. The unemployment rate fell to 4.1% in September and remained at that level in October. The uncertainty in the economy due to weather, strikes, and elections will make it more difficult for officials to clearly express their future plans. Third, where is inflation headed? The PCE inflation, which is the Federal Reserve's preferred measure, has been slowing down. This index rose by 2.1% year-on-year in September. Another measure that excludes the volatile food and energy prices, known as core inflation, stands at 2.7%. Core inflation has significantly decreased from levels seen in 2023, which is why the Federal Reserve began to cut interest rates. However, if inflation appears to stagnate while the economy is thriving, some officials may call for a slowdown in the pace of rate cuts. Fourth, what is the appropriate level of interest rates? After rapidly raising borrowing costs over two years to combat inflation, officials are trying to bring rates back to a more "normal" level. But they do not know what a normal rate is. Before the 2008-09 financial crisis, many believed that a normal or "neutral" level that neither stimulates nor suppresses the economy might be around 4%. Currently, the benchmark federal funds rate is in the range of 4.75% to 5%. However, after the crisis and an extremely slow recovery, economists have concluded that this normal or neutral level may have fallen to around 2%. Powell stated at a press conference in September that he does not believe the Federal Reserve's policy rate will return to such a low equilibrium level. He said, "We will see, in my view, the equilibrium rate may be much higher than it was then." As the Federal Reserve lowers rates to a lower level, the question of the ultimate destination will become more urgent. If the economy performs well, those officials who believe the equilibrium rate is higher may ultimately wish to slow the pace of rate cuts to avoid exceeding the equilibrium level