The Federal Reserve will start cutting rates soon. Here are 3 factors that weigh on this decision.
Federal Reserve Chairman Jerome Powell said they’re not far from cutting interest rates. The statement came during a remark to the Senate Banking Committee on Thursday. Simultaneously, US President Joe Biden was giving his State of the Union address to Congress.
“We’re waiting to become more confident that inflation is moving sustainably at 2%,” Powell said. “When we do get that confidence, and we’re not far from it, it’ll be appropriate to begin to dial back the level of restriction.”
The Fed brought rates to a 40-year record high in a cycle ending in 2023. In 11 consecutive meetings, Powell and the committee brought interest rates to 5.5%. The latest hike took place in June 2023, leaving rates unchanged afterward.
The monetary tightening helped bring inflation to manageable levels. At its peak, post-Covid inflation reached over 9% in the United States, falling to 2.4% in the latest reading. The Federal Reserve, like most of the world’s central banks, set its inflation target at 2%.
During his speech, Powell dismissed any talks about increasing the inflation target to meet current price levels.
Now investors are waiting more or less patiently for Powell to start cutting rates. Feeling also the pressure from the Democratic Party, Powell is slowly starting to change his narrative.
Inflation, the economy, and politics
Three factors will influence the upcoming monetary strategy of the Federal Reserve: inflation, the economy, and the 2024 US elections.
Inflation data in the following months will be the most important factor. As Powell repeated many times, the committee needs to see inflation on a clear path to the target before cutting rates. Although prices have cooled in recent months, they were more volatile than what the Fed would like.
At the same time, however, the Fed needs to avoid the US tipping into recession. Though this prospect seems unlikely, leaving interest rates too high for too long might stop economic growth.
Finally, Jerome Powell is quite clearly aligned with President Joe Biden to ensure his reelection in November. Though the Federal Reserve is technically apolitical, Republican candidate Donald Trump often expressed his disdain for Powell and would likely remove him from office if elected.
To give Biden more chances of reelection, the Federal Reserve must pave the way for a growing economy in Q4. For this reason, it’s been pressured by the Democratic Party to cut rates as early as possible.
Balancing these three aspects is a tall order. Powell and the committee have several factors to consider, and there is little room for error.
