Federal Reserve News: Interest Rate Decision and Economist Predictions

The Fed's Balancing Act

The Federal Reserve finds itself in a familiar, yet precarious, position as we approach the end of 2025: navigating the treacherous waters of inflation and employment. Recent signals from the Fed suggest a willingness to cut interest rates further, even as inflation remains stubbornly above target. The question is, can they pull it off without capsizing the economy?

The argument for rate cuts hinges primarily on the labor market. Bill Merz at U.S. Bank Asset Management Group points to "negative labor market revisions" as a key factor influencing the Fed's decisions. This aligns with the Fed's dual mandate: keeping both inflation and unemployment in check. A weaker labor market theoretically justifies lower rates to stimulate hiring and economic activity. It's a classic Keynesian move, but with Trump-era tariffs still casting a shadow, the playbook gets a little muddier.

Powell himself acknowledged the "downside risks to employment" in September. However, the absence of official jobs data due to the government shutdown adds a layer of uncertainty. Powell claims access to alternative data sources, but how reliable are these private-sector metrics? What methodologies are they using? The lack of transparency is concerning, and I'm not sure the Fed is being transparent enough about how they are making these decisions.

Tariffs and the Inflation Puzzle

The elephant in the room is, of course, inflation. Despite the Fed's efforts, inflation remains elevated. The Consumer Price Index (CPI) rose 3% last month, which is "cooler than expected," according to some economists. But let's be clear: 3% is still above the Fed's 2% target. The muted impact of Trump's tariffs on inflation is presented as a positive, but is it really? Or is it simply a delayed reaction, a slow burn that will eventually ignite?

Powell previously stated that the "pass through [of tariffs] has been pretty small" to consumers, but that companies intend to pass along more cost increases. This creates a potential inflationary pressure cooker. Business "prices paid" surveys and rising tariff revenue could push goods inflation higher, forcing the Fed to reconsider its dovish stance. It's a delicate balancing act: cutting rates to support employment while simultaneously trying to contain inflation fueled, in part, by protectionist trade policies. It's like trying to steer a ship with a broken rudder.

The market seems to be betting on the Fed to pull it off. Market prices indicate a 72% chance of another 0.25% rate cut at the December meeting, with further cuts expected next year, potentially bringing the policy rate near 3.0%. This optimism is reflected in recent stock market strength, suggesting investors believe the Fed is responding to past soft data, not future growth concerns. But are they right? Or are they simply ignoring the potential inflationary risks lurking beneath the surface?

The Balance Sheet Wildcard

Adding another layer of complexity to the equation is the Fed's balance sheet. After years of quantitative easing (QE) in response to the COVID-19 pandemic, the Fed is now trying to normalize its balance sheet by reducing its holdings of bonds. However, they announced that they will cease reducing their $6.3 trillion in holdings on December 1, after slowing the monthly reduction earlier this year. (Bond holdings peaked at $8.5 trillion in 2022.)

Halting balance sheet reduction is intended to improve market liquidity, providing a cushion against financial shocks. Strong liquidity is undoubtedly a good thing, but it also risks fueling asset bubbles and exacerbating inflationary pressures. It's a classic case of "damned if you do, damned if you don't."

Governor Waller's remarks at the Payments Innovation Conference offer a glimpse into the Fed's thinking. He emphasizes the importance of embracing private-sector innovation in payments, including stablecoins, tokenized assets, and AI. He even floated the idea of a "payment account" (a "skinny" master account, as he calls it) to provide basic Federal Reserve payment services to legally eligible institutions focused on payments innovations. The idea is to tailor the services of these new accounts to the needs of these firms and the risks they present to the Federal Reserve Banks and the payment system.

This embrace of innovation is a welcome sign, but it also raises questions. How will the Fed regulate these new technologies? How will they ensure the safety and stability of the payment system in the face of rapid technological change? And, perhaps most importantly, how will they prevent these innovations from exacerbating existing financial risks?

A Calculated Gamble

The Fed's current policy stance is a calculated gamble. They are betting that they can fine-tune interest rates and manage their balance sheet to achieve their dual mandate of low inflation and full employment. But the risks are significant. A misstep could lead to either runaway inflation or a sharp economic downturn.

And this is the part of the analysis I find genuinely puzzling: Why is the Fed so focused on short-term labor market data when the long-term inflationary risks are so apparent? It's as if they are driving while only looking in the rearview mirror.

Is the Fed Overplaying Its Hand?