US Fed prepares for first interest rate cut in over four years ahead of 2024 presidential elections

The United States Federal Reserve (US Fed) this week is expected to announce its first interest rate cut in over four years since 2020, months ahead of the US presidential elections scheduled in November 2024, AFP reported.

It added that Fed policymakers will debate how big the cut will be ahead of the announcement expected on September 18 (US local time) this week.

Senior Fed officials, including Chair Jerome Powell, have indicated that a rate cut is imminent, as inflation in the US eases towards the central bank’s target of 2 per cent, and as the labour market continues to cool, the report added.

‘Rate Cut Solely on Economic Data’

The US Congress mandates that the central bank ensure stable prices and sustainable employment through independent action, and the Fed has often stressed that its rate cut decision will be based “solely on the economic data”, the AFP report said.

A cut this week would still be a “headache” for Powell, as it comes just two months before the election clash between Kamala Harris (Democratic nominee and US Vice President) and Donald Trump (Republican nominee and former US President).

“As much as I think the Fed tries to say that they’re not a political animal, we are in a really wild cycle right now,” Alicia Modestino, an associate professor of economics at Northeastern University and former senior economist at the Federal Reserve Bank of Boston, told AFP.

How Big a Cut to Expect?

September 17-18 will see policymakers debate on whether to move the cut by 25 basis points or 50 basis points (bps).

However, either number would be significant since this is the Fed’s first cut since March 2020, when it slashed rates to near-zero, in order to support the US economy through the COVID-19 pandemic.

The Fed began its rate hikes in 2022 in response to a surge in inflation, fueled largely by a post-pandemic supply crunch and the war in Ukraine; and has held its key lending rate at a two-decade high of between 5.25 and 5.50 per cent for the past 14 months, waiting for economic conditions to improve.

Now, with inflation falling, the labour market cooling, and the US economy still growing, policymakers have decided that conditions are ripe for a cut.

Ease Into Things vs Be More Aggressive

Policymakers are left with a choice: make a small 25 bps cut to ease into things or a more aggressive 50 bps cut to help the labour market despite the risk of reigniting inflation.

“I think that in advance of the November meeting, there’s not quite enough data to say we’re in jeopardy on the employment side,” Modestino stated.

Analysts see the smaller cut as a safe bet. “We expect the Fed to cut by 25bp (basis points),” economists at Bank of America wrote in a recent note to clients.

“The Fed likes predictability. It’s good for markets, good for consumers, good for workers. So a 25 basis point cut now, followed up by another 25 basis point cut in November after the next round of economic data, offers a somewhat smoother glide path for the economy,” Modestino added.

How Many Cuts Are Expected?

While analysts overwhelmingly expect the US Fed to start rate cuts in September, there is less clarity about what will follow. Many hope the central bank will illuminate their path in the updated economic forecast to be published on September 18.

The forecast will be from the Fed’s 19-member rate-setting committee and will include their rate cut expectations, the report added.

In June, FOMC members sharply reduced the number of cuts they had pencilled in for this year from a median of three down to just one amid a small uptick in inflation. But as inflation has fallen and the labor market has weakened, expectations of more cuts have grown.

“We continue to expect three rate cuts of 25 bps each at the remaining 2024 FOMC meetings,” Goldman Sachs chief economist Jan Hatzius wrote in a note to clients last week.

Traders also see a greater-than 99 per cent chance of at least four more cuts in 2025, which would bring the Fed’s key lending rate down to between 3.5 and 3.75 per cent — 175 bps below current levels.