Federal Reserve flies blind as rate-cut decision looms

US central bank poised to cut rates again but government shutdown clouds data

Fed Chair Jerome Powell. The US central bank has not been provided with economic data it relies on as the government is shut down. Reuters

The Federal Reserve is set to enter this week's policy meeting with little clarity, as the US government shutdown further complicates what is already a cloudy economic picture.

The US central bank, whose rate-setting decisions are followed by most central banks in the Gulf because of the dollar peg, has already been staring down a predicament that Fed Chair Jerome Powell describes as “no risk-free path”.

Those risks are on both sides of the Fed's dual mandate – price stability and full employment. The US government shutdown, currently the second-longest in the nation's history at 26 days and counting, has largely deprived the Federal Reserve of the data it needs to assess the path forward.

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When the Fed last met in September, policymakers signalled they were prepared to cut rates by a cumulative 75 basis points this year. With little data coming in since then, traders anticipate the Fed will cut rates by 25 basis points on Wednesday, bringing down the target range to 3.75 to 4 per cent.

“Because of the shutdown … there just has not been anything in the last six weeks of data, or lack of data, to convince them that anything has changed significantly from that assessment,” said Michael Pearce, deputy chief US economist at Oxford Economics.

A delayed September inflation report released on Friday boosted hopes for a rate cut this week, resulting in a US market rally that brought a new record-high for the Dow. The report showed headline inflation rose 0.3 per cent on a monthly basis and 3.1 per cent year-on-year, slightly softer than anticipated.

But analysts say it did little to change the picture heading into this week's meeting.

“The key driver is all around the risk of the labour market,” Mr Pearce said.

With the shutdown preventing the Labour Department releasing its monthly jobs report, greater attention was fixed on data from the private sector. The data, released by payrolls processing firm ADP, showed employers shed a seasonally adjusted 32,000 jobs last month, further cementing fears of a slowing labour market that first emerged over the summer.

“Rising downside risks to employment have shifted our assessment of the balance of risks,” Mr Powell said in prepared remarks at an event in Philadelphia this month.

With the government shutdown approaching its fifth week, its effects could stretch beyond data collection. Treasury Secretary Scott Bessent said on the sidelines of the International Monetary Fund and World Bank annual gatherings the shutdown was beginning to “cut into the muscle” of the US economy, with the department saying it is causing an economic loss of roughly $15 billion per week.

A separate analysis from accounting firm KPMG estimates the shutdown is shaving roughly 0.2 per cent from real GDP growth per week.

“If we're getting a prolonged shutdown, then there could be some impairment and harm done to consumer demand over time, the longer this drags on,” said Derek Tang, an economist at LHMeyer/Monetary Policy Analytics.

He also said the shutdown could impact businesses which could rely on government approvals to carry out projects or continue their current operations.

“And that might not be seen for another few months,” he said.

The shutdown also comes amid continued tariff uncertainty, with President Donald Trump recently cancelling trade negotiations with Canada over an advert that used former president Ronald Reagan's likeness to criticise current US policy. Canada is the US's second-largest trading partner by goods, with total trade totalling $428.8 billion year-to-date in July, according to Census Bureau data.

Meanwhile, the US Supreme Court is expected to hear a pair of legal challenges to Mr Trump's emergency powers to impose tariffs. Oral arguments are scheduled for the first week of November.

Balance sheet run-off

Expectations are also growing on Wall Street that the Federal Reserve is preparing to halt its balance sheet run-off.

The Federal Reserve has been reducing the size of its balance sheet – a term known as quantitative tightening, or QT – since 2022. QT and its reverse policy – quantitative easing, or QE – are other means the Fed uses to influence interest rates.

Since then, the Fed has reduced the size of its balance sheet by $2.2 trillion, with Mr Powell saying that the Fed intends to stop balance sheet run-off when its reserves are slightly above the level the Fed believes to be consistent with ample reserve conditions.

“We may approach that point in coming months, and we are closely monitoring a wide range of indicators to inform this decision,” he said in prepared remarks in Philadelphia during an event before the Fed's blackout period.

While a rate cut this week is seen as a sure thing by investors and analysts, less certain is when the Fed will announce the end of QT.

“We know bank reserves are getting down close to the sort of level that the Fed thinks is consistent with ample reserves,” said Mr Pearce. “I think that under Powell, this Fed is taking a relatively cautious approach to balance sheet management.”