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The Federal Reserve is preparing to adjust interest rates amid political changes

The Federal Reserve is preparing to adjust interest rates amid political changes

Federal Reserve Chair Jerome Powell will address the nation following the conclusion of the Federal Open Market Committee (FOMC) meeting, where another interest rate cut is expected. Scheduled for Thursday, this meeting comes at a time when the economic landscape has become increasingly complex.

Financial markets are all but certain that the central bank will reduce its benchmark borrowing rate by 0.25%, aiming to recalibrate its policies in light of moderate inflation and a weakening labor market. However, the real focus will be on the Fed's prospects as it adapts to the evolving economy and the political ramifications of Donald Trump's unexpected presidential victory.

Krishna Guha, head of global policy and central bank strategy at Evercore ISI, suggests that Powell will likely refrain from making snap judgments on the economic implications of the election. Instead, his goal is to project stability and calm during this period of transition. Guha stresses that Powell will underline the Fed's commitment to carefully evaluate the new administration's plans before making any decisions regarding monetary policy.

While the immediate action will involve executing the rate cut, which will adjust the federal funds rate to a range between 4.75% and 5.0%, market participants will be very interested in the future indications of the Fed. Current market sentiment tends to anticipate another quarter-point cut in December, followed by a pause in January, with further reductions expected throughout 2025.

If Trump's proposed economic policies – such as tax cuts, increased government spending and protective tariffs – are implemented, they could have a significant impact on the Fed's approach. Many economists fear that such isolationist measures could reignite the inflation, which remained below 3% during Trump's first term, despite similar strategies.

During his presidency from 2017 to 2021, Trump was often critical of Powell and the Federal Reserve, advocating lower interest rates to stimulate the economy. Quincy Krosby, chief global strategist at LPL Financial, points out that while the market is focused on future rate cuts, there is also an urgent question as to whether inflation can truly be considered under control.

The answers to these questions will largely emerge from Powell's post-meeting press conference. While the committee will announce its rate decision, it will not release an updated summary of economic projections (SEP), which includes forecasts for inflation, GDP growth and unemployment, along with FOMC members' individual rate expectations.

Looking beyond January, uncertainty looms over the Fed's future direction. The SEP is expected to be updated again in December, but for now, Krosby stresses that discussions about the so-called “terminal rate” will gain traction. If bond yields continue to rise, this term could become more important in monetary policy conversations, even if it is not exclusively tied to economic growth.

In the federal funds futures market, traders expect a rapid round of cuts, predicting that the benchmark rate could fall to a target range of 3.75% to 4.0% by the end of 2025. This would represent a decrease of a full percentage point from the current level, following the expected 0.5% reduction for September. In contrast, the secured overnight financing rate suggests a more cautious outlook, with a potential short-term rate of around 4.2% by the end of next year.

A fundamental question remains: what will be the end point of this cycle of rate cuts? Bill English, the Fed's former head of monetary affairs and now a finance professor at Yale, notes that the Fed will soon have to consider the implications of a robust economy on its rate-cutting strategy. It suggests the central bank may want to pause and assess how the economic landscape evolves.

Additionally, Powell may have to address the Fed's ongoing efforts to reduce its bond portfolio. Since this process began in June 2022, the Fed has reduced its holdings of Treasuries and mortgage-backed securities by nearly $2 trillion. Although Fed officials have indicated that balance sheet reductions may continue even in the event of rate cuts, market expectations suggest that this initiative could end as early as 2025.

English points out that while the Fed has kept the issue on the back burner, there will be greater interest in future meetings regarding the pace of these asset outflows and when further adjustments might be made.

As the Federal Reserve navigates these uncertain waters, the implications of economic policies and political developments will undoubtedly influence its decisions in the months ahead. Investors and analysts alike are watching closely, anticipating how Powell and his team will respond to both current economic conditions and the broader political landscape.

By Isabella Turner

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