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Next Week's Fed Meeting: Is Another Rate Cut Coming?

| MoneyRates.com Senior Financial Analyst, CFA
min read




Will next week's meeting of the Federal Open Market Committee (FOMC) result in another rate cut?

Given the general feeling of pessimism about the economy and the possibility of a recession in 2020, expectations for a rate cut next week are high.

Still, the story isn't all one-sided.

The FOMC, which is the Federal Reserve committee that decides monetary policy, has cut rates at its last two meetings. These were the first rate cuts since the recessionary environment of 2008, and they came after nine consecutive fed-rate hikes from late 2015 to late 2018.

Will the Fed continue the recent trend toward lower rates - or will it go into wait-and-see mode to assess the impact the two previous rate cuts have had on the economy?

Economic Status Check: Employment and Inflation

To understand why there is widespread expectation that the Fed might lower rates, one only has to look at the two things that the FOMC consistently cites as being central to its job description: encouraging employment growth and controlling inflation.

Generally speaking, lower interest rates encourage employment - but they can also fuel inflation. So, if slow job growth is the primary concern, the Fed tends to lean toward lower rates. However, if inflation is threatening to get out of hand, the Fed tends to raise rates to rein it in.

The following is a summary of where employment and inflation stand these days:

1. Employment growth has slowed

Job growth is on track for its weakest year since 2010, when the economy was still recovering from the Great Recession.

Even so, the unemployment rate is just 3.5%, which is fairly low by historical standards.

So is this just a case of the glass being half full and half empty?

There are reasons why many economists are focused on the half-empty part of the glass:

  • People may have dropped out of the market

    The unemployment rate is based on the current labor force, which only accounts for people who are either working or actively looking for a job. The percentage of working-age people who are participating in the labor force has declined noticeably over the past 20 years, suggesting many people have simply dropped out of the job market.

Why do people drop out of the job market?

It may be due to a mismatch between jobs and potential workers when it comes to locations, skills or wage expectations.

  1. Indications of this kind of mismatch include the wide differences in unemployment rates among the 50 states, ranging from a low of 2.1% to a high of 6.2%.
  2. Another indication is that, while overall employment has continued to grow, the average weekly hours worked in the manufacturing sector has declined this year.
  3. In terms of a mismatch of wage expectations, consider the fact that inflation-adjusted wage growth has risen by just 0.6% a year since the end of the recession and was negative in September.

Clearly, a low unemployment rate is not creating the type of demand for labor that would drive wages higher in a more meaningful way.

Continued strong job growth could potentially help solve the problems of low labor-force participation and slow wage growth. Increased demand from employers could force wages higher and lure more people into the job market. However, with job growth fading in 2019, the problems of low labor-force participation and slow wage growth look likely to continue.

A key piece of economic data won't be available until the morning of October 30, just hours before the next FOMC rate announcement. That's when the Bureau of Economic Analysis (BEA) gives its first estimate of third quarter, 2019 growth.

No doubt the Fed will already have analyzed its own data to make a preliminary growth estimate, but the BEA announcement will help the public and the financial community put the FOMC's decision in perspective.

2. Inflation has cooled off again

Inflation perked up earlier this year, rising at a 2.8% annual rate from the end of January through the end of July.

But while 2.8% isn't too crazy a rate of inflation, it is above the Fed's target of 2%. Having inflation run above its target could make the Fed hesitate to lower rates, but the Consumer Price Index has more or less flat-lined over the past two months.

This calming of inflation coupled with the cooling of the job market would appear to give the Fed both the opportunity and the motive to lower interest rates.

The Federal Funds Rate and the Bond Market

Too often, financial commentators give the impression that the Fed controls interest rates. For the most part, the Fed just reacts to the same economic forces that drive other interest rates. In fact, market-based interest rates often move more quickly than the Fed.

Take U.S. Treasury yields, for example. These started to decline well before the Fed first lowered rates at the end of July - in some cases, Treasury yields started to decline late last year, when the Fed was still raising rates.

Falling Treasury yields suggest bond traders are concerned that the economy is weakening and don't see inflation as an imminent threat. In short, they see the same conditions that could prompt the Fed to lower rates.

Are Rates Already too Low?

So, conditions are in place for the Fed to lower interest rates - unless actions they've already taken have left rates sufficiently low.

For one thing, on both an absolute and an inflation-adjusted basis, current fed funds rates are already lower than historical norms. This is less because of the recent fed rate cuts than because the Fed was relatively cautious in raising rates after cutting them drastically during the financial crisis.

Also, the FOMC's recently updated economic projections suggest that the Fed itself does not expect rates to go much lower than their current levels.

Those projections showed that the Fed expects the fed funds rate to be at 1.9% at the end of this year and next year. While that is lower than the previous projections made in June, 1.9% is within the current fed funds rate target range of 1.75% and 2.00%.

Of course, those projections along with the actual fed funds rate are subject to being revised based on upcoming economic developments. For the time being, though, if the Fed does lower rates at next week's meeting, it will be a signal that its outlook for the economy has grown more pessimistic since the mid-September meeting.

Previous Federal Reserve Board Updates articles:

FOMC Date2019 FOMC Meeting Update Articles
08/01/2019July 2019 Fed Meeting Raises New Questions
06/20/2019Consumers Not Limited by Fed's Rate Decision
05/2/2019Federal Reserve Pursues Rate Stability
03/21/2019Shifting Stance: Fed Implies No Rate Increases in 2019
1/31/2019Fed's Low Profile Won't Stop Interest Rates from Rising

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