The Fed is on observe to chop rates of interest in December, however what occurs subsequent stays unclear

Federal Reserve Chairman Jerome Powell during the New York Times DealBook Summit at Jazz at Lincoln Center in New York, USA, on Wednesday, December 4, 2024.

Yuki Iwamura | Bloomberg | Getty Images

Friday's jobs report all but confirms that the Federal Reserve will agree to a rate cut at its meeting later this month. Whether this should be the case and what it does from there is another question.

The not-too-hot, not-too-cold nature of the November non-farm payrolls release gave the central bank the remaining room it might have needed to move, and the market responded in kind, raising the implied probability of a cut to near increased 90%, according to a measurement by CME Group.

However, the central bank is likely to face heated debate in the coming days about how fast and how far it should go.

“Financial conditions have eased massively. The Fed is at risk of creating a speculative bubble here,” Joseph LaVorgna, chief economist at SMBC Nikko Securities, said on CNBC’s “Squawk Box” after the report was released. “There is no reason to lower interest rates at the moment. You should take a break.”

LaVorgna, who served as a senior economist during Donald Trump's first term and could serve in the White House again, was not alone in his skepticism about a Fed rate cut.

Chris Rupkey, senior economist at FWDBONDS, wrote that the Fed “doesn't need to tinker with measures to stimulate the economy as jobs are plentiful,” adding that the central bank's stated intention to cut interest rates further is “always seems more unwise since this is the case. The inflationary fire has not been extinguished.”

Jason Furman, himself a former White House economist under Barack Obama, expressed caution during his appearance with LaVorgna on CNBC, particularly regarding inflation. Furman noted that the recent pace of average hourly wage growth is more consistent with a 3.5% inflation rate, rather than the Fed's preferred 2%.

“This is another data point in the no-landing scenario,” Furman said of the jobs report, using a term that refers to an economy where growth continues but also triggers more inflation.

“I have no doubt that the Fed will cut rates again, but when they will cut rates again after December is unclear, and I think that will require more of an increase in unemployment,” he added added.

factors in the decision

In the meantime, policymakers have a mountain of information to wade through.

First off, November's payroll data showed an increase of 227,000, slightly better than expected and a big step up from October's paltry 36,000. Adding the two months together – October was impacted by Hurricane Milton and the Boeing strike – results in a net average of 131,500, slightly below the trend since the labor market first began to rock in April.

But even if the unemployment rate rises by 4.2% due to a decline in household employment, the labor market situation still looks solid, if not spectacular. Payrolls still haven't decreased in a single month since December 2020.

However, there are other factors.

Inflation has started to rise recently, with the Fed's preferred measure rising to 2.3% in October, or 2.8% if food and energy prices are excluded. Wage growth also remains robust, with the current 4% well above the pre-COVID period, which dates back to at least 2008. Then there is the question of Trump's fiscal policies as he enters his second term and whether his plans to impose tariffs will fuel inflation even further.

The overall economy has now grown strongly. According to the Atlanta Fed, the fourth quarter is on track to record an annual gross domestic product growth rate of 3.3%.

There's also the issue of “financial conditions,” a measure that includes things like Treasury and corporate bond yields, stock market prices, mortgage rates, and the like. Fed officials believe the current range of its federal funds rate of 4.5% to 4.75% is “restrictive.” However, according to the Fed's own information, financial conditions are the loosest they have been since January.

Earlier this week, Fed Chairman Jerome Powell praised the U.S. economy, calling it the envy of the developed world and saying it offers policymakers a buffer to move slowly in rebalancing their policies.

Cleveland Fed President Beth Hammack on Friday pointed to the strong growth and said she needed more evidence that inflation was moving convincingly toward the Fed's 2 percent target. Hammack argued that the Fed should slow its rate cuts. If the December cut is implemented, it will represent a full percentage point drop since September.

Looking for neutral

“In order to balance the need to maintain a slightly restrictive monetary policy stance with the possibility that policy may not be far from neutral, I think we are at or near the point where it makes sense to slow the pace of rate cuts,” said Hammack, a voting member on the Federal Open Market Committee this year.

The only thing left on the agenda that could dissuade the Fed from cutting interest rates in December is the release of separate reports on consumer and producer prices next week. The consumer price index is expected to rise by 2.7%. Fed officials will enter the quiet period after Friday, during which they will not make any monetary policy statements before the meeting.

The issue of a “neutral” interest rate that neither restricts nor stimulates growth is central to Fed policy. Recent signs suggest that levels could be higher than in previous economic climates.

What the Fed could do is cut rates in December, skip January, as traders expect, and perhaps cut again in early 2025 before pausing, said Tom Porcelli, chief U.S. economist at PFIM Fixed Income .

“I don’t think there’s anything in today’s data that would actually stop them from making cuts in December,” Porcelli said. “When they raised interest rates so much, it was for a completely different inflation regime than what we currently have. In this context, I think Powell would like to continue the process of policy normalization.”

Powell and his policy colleagues say they are now paying equal attention to controlling inflation and supporting the labor market, whereas previously the focus was much more on prices.

“If you want to wait until you see cracks from a labor market policy perspective and then start adjusting policy downwards, it’s too late,” Porcelli said. “So it would really be prudent for you to start this process now.”