MW This week's Fed meeting will highlight the central bank's challenge: Preventing a recession while tackling inflation
By Greg Robb
The Fed is widely expected to cut interest rates for the third meeting in a row when it meets this week
In October, Federal Reserve Chair Jerome Powell said a December interest-rate cut was far from a foregone conclusion. Now, it's expected to happen.
Six weeks ago, Federal Reserve Chair Jerome Powell surprised everyone by saying that an interest-rate cut at the central bank's next meeting in December was unlikely to happen.
Now, days away from that meeting, Fed officials have clearly signaled they plan to cut rates by a quarter of a percentage point for the third straight meeting. Late last month, New York Fed President John Williams, a close ally of Powell's, said in a speech that he saw room for a further rate cut. The market took his comments as a green light for an easing.
So, what changed?
"The only thing that matters is the unemployment rate," said Julia Coronado, president of MacroPolicy Perspectives.
The delayed September jobs report - the first piece of important U.S. economic data to be released after the government shutdown ended - showed that during the period the Fed was flying blind, the jobless rate continued to tick up to 4.4%.
That has convinced Powell and a majority of his colleagues that another rate cut is justified, Coronado said.
Fed officials will meet on Dec. 9-10 to discuss interest-rate policy. Their decision will be announced at 2 p.m. Eastern time, followed by a Powell press conference at 2:30 p.m.
Since the summer, the Fed has been confronted with two worrisome trends occurring at the same time: high inflation and a weak labor market. It's a bind they're unlikely to shake anytime soon.
"I think that's a real dilemma," said Coronado - because while an economic downturn would lead to declining inflation, it's the Fed's job not to cause a recession. "So they really are stuck with hard choices," she added.
Even if Fed officials vote to slash rates this month, it's likely Powell and other policymakers will make clear that the bar for future rate cuts is high as concern for inflation remains. Both consumers and officials have been focused on affordability, and cutting rates too much risks driving up inflation.
For many at the Fed, addressing the weakening labor market appears to be the most prudent path forward - at least for now. James Egelhof, chief U.S. economist at BNP Paribas, said the pickup in the unemployment rate showed the economy is unlikely to overheat in the near term and that another rate cut wouldn't spark higher inflation.
What's more, a weakening labor market puts the U.S. economy at risk of falling into a recession - an outcome the central bank wants to avoid.
Officials have been trying to execute a 'soft landing' for years
The Fed pushed its benchmark interest rate up to a range of 5.25% to 5.5% in 2023, in order to combat higher inflation that surprised the central bank in the aftermath of the COVID-19 pandemic. Next week's likely cut would lower the Fed's benchmark rate to a range of 3.5% to 3.75%.
Over this period, the Fed has tried to engineer a so-called soft landing - cutting rates to protect the economy from a recession without sparking inflation.
But the last mile of inflation has proved difficult.
After spiking to 9% in June 2022, consumer-price inflation fell to a 2.3% rate in April. But climbed back up to 3% in September, well above the Fed's 2% inflation target.
Yet as the U.S. labor market has struggled over the past several months, most Fed officials have shifted their focus away from inflation and toward worries that the economy might stumble into a recession. They've also been contenting with pressure from President Donald Trump and the financial markets to slash rates.
Over the summer, the labor market changed from one characterized by steady job growth to one defined by low hiring but also low firing. Still, the unemployment rate picked up to 4.4% in September, from 4.0% at the beginning of the year.
The Fed is worried that if companies start to increase layoffs, the result would be a dramatically weaker labor market, which could trigger a recession.
The majority of Fed officials who favor a rate cut believe the weakening labor market will ultimately bring inflation down, which gives them room to cut, Coronado said.
Drew Matus, chief market strategist for MetLife Investment Management, pointed out that a recent survey of consumers by the Conference Board found those who think jobs are "plentiful" plunged to 27.6% in November, from 40.4% at the end of 2023.
These data have been pretty good at predicting the direction of unemployment, Matus noted. "When it falls the way it is currently falling, the unemployment rate tends to be moving up decisively towards at least a 5% mark," he said.
Some Fed officials are still focused on inflation
A sizable minority at the Fed think the central bank should keep its focus on inflation. They note that weekly claims for state unemployment insurance, a sign of layoffs in the economy, have stayed remarkably low.
These officials are restless about inflation that has been above the Fed's 2% target for more than four years.
To placate these policymakers, some economists think the Fed will signal that the bar for future rate cuts is high, said Egelhof of BNP Paribas.
"We're expecting Powell to raise the bar for further easing at the press conference by saying that these pre-emptive management cuts are complete for now and that further policy loosening is going to be conditioned on the outlook as reflected in the economic data," he said.
Despite this caution about additional cuts, several Fed officials are expected to dissent, indicating that they want to keep rates unchanged. There could be as many as three dissents arguing for holding rates steady next week, according to economists at BofA Securities.
There will be a flood of new economic data before the Fed's following meeting at the end of January. Key reports on inflation and jobs from October and November will be released, along with more contemporaneous reports.
Given the amount of data to be released before that Jan. 27-28 meeting, Aditya Bhave, senior U.S. economist at BofA Global Research, said he's skeptical that Powell can be credibly hawkish. The economic data the central bank gets between now and the end of January could signal a further weakening in the labor market and a need for more cuts.
"We wouldn't be surprised if markets start pricing a January cut more aggressively in the near term," Bhave said in a research note.
At the moment, financial markets have two rate cuts priced in for 2026. The Fed currently has one cut pencilled in, and will update this forecast next week.
MacroPolicy's Coronado noted that Powell will likely say "a thousand different ways" that the next move on interest rates will depend on the data and the outlook.
In general, economists think the Fed will ignore the rising speculation that Trump is close to announcing a replacement for Powell.
Multiple reports have suggested that Kevin Hassett, one of Trump's top economic advisers, is the leading candidate. In general, Hassett is seen as a loyalist who will pursue lower interest rates.
But there is no guarantee that rates can fall sharply next year, a point that the outcome of the Fed's December meeting will likely underscore.
Any new Fed chair will have to convince investors that the Fed is not abandoning its 2% inflation target, or else risk the bond market pricing in higher long-term rates.
Indeed, Americans' current focus on affordability is concerning for the Fed, Coronado said.
Former Fed Chair Alan Greenspan once said the definition of stable inflation is when consumers and businesses aren't talking about higher prices.
"The fact that affordability is the dominant conversation in the culture at large is a real threat to [the Fed's] credibility," Coronado said.
-Greg Robb
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(END) Dow Jones Newswires
December 06, 2025 09:00 ET (14:00 GMT)
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