Federal Reserve poised for final rate cut this year amid growing divisions

Markets coalesce around quarter-point cut, but road forward grows more uncertain

Fed Chair Jerome Powell is steering an increasingly divided ship. Bloomberg

The Federal Reserve is poised to cut US interest rates for a third consecutive time as it readies for its final meeting this year amid growing divisions over future moves and little clarity on the economic outlook.

At the heart of this discussion is the Fed's dual mandate, which makes the US central bank distinct among its peers. For months, the Federal Open Market Committee (FOMC) has been grappling with which side of this mandate to prioritise: tackling inflation or shoring up employment.

“In this scenario, there are no easy answers. The question is, which side do they want to be wrong on,” said Derek Tang, an economist at LHMeyer/Monetary Policy Analytics.

Signals in futures markets indicate the Fed will, for a third straight time, coalesce around employment concerns and cut rates by 25 basis points, according to CME Group data. Six of the seven central banks in the Gulf Co-operation Council are expected to follow the Fed's decision because of their currency pegs.

Hawks and doves

Fed observers anticipate dissent to emerge following the central bank's decision on Wednesday. This underscores the lack of clarity facing a rate-setting body that has often moved in unison throughout Fed Chair Jerome Powell's seat at the centre of the table.

“The FOMC has grown increasingly split over its near-term course of action,” Wells Fargo economists wrote to clients.

Data in recent months has shown increasing tension between inflation, which remains above the Fed's 2 per cent target, and a weakening labour market. Interest rates are the Fed's primary tool to address these, but it cannot tackle both simultaneously.

Fed hawks, who are more cautious about rate cuts, have expressed greater concern that inflation has not meaningfully climbed down towards the 2 per cent target. Hawkish dissent has been most profound among regional Fed presidents, who serve rotating terms on the FOMC.

“It will likely be appropriate to keep policy rates at the current level for some time to balance the inflation and employment risks in this highly uncertain environment,” Boston Fed President Susan Collins said last month.

Delayed core inflation data released on Friday clocked in at 2.8 per cent year-on-year in September, only slightly below the August reading.

Two influential Fed members have expressed more dovish views, however, leading markets to price in a rate cut this week. Fed governor Christopher Waller and New York Fed president John C Williams both cited a weakening labour market in their support for a cut.

Fed governor Christopher Waller. Bloomberg

“A December cut will provide additional insurance against an acceleration in the weakening of the labour market and move policy towards a more neutral setting,” said Mr Waller, who is on President Donald Trump's shortlist to replace Mr Powell as Fed chair next year.

Private-sector data released by ADP last week showed a 31,000 decline in private payrolls, with small businesses feeling the brunt of the cuts.

Separate private data from Challenger, Gray & Christmas showed that layoffs in November rose 24 per cent compared to the same time last year. But layoff plans also fell, the firm's chief revenue officer Andy Challenger said in the report.

Adding to the murky data is the nation's unemployment rate which remains at a steady 4.4 per cent, according to Chicago Fed data.

Consumer sentiment remains low heading into the holiday shopping season as the burden of high prices continues. At the same time, key economic data has either been delayed or cancelled because of the shutdown this autumn.

I think Powell wants to put his foot down

Derek Tang,
LHMeyer / Monetary Policy Analytics

Absent from the discourse has been Mr Powell, who must steer the committee towards his preferred move. Two ways to win over potential dissenters would be to push against market expectations in the Fed's post-meeting statement or during his press conference.

“I think Powell wants to put his foot down,” Mr Tang said.

“That does several things. That says the bar for cutting again in January or March is higher … That would help him defeat some of the internal tension on the committee [as] an increasing group don't want to cut any further.”

A screen at the New York stock exchange broadcasts a news conference by Fed Chair Jerome Powell following the rate announcement in September. Reuters

Change in the air

With little government data having come in since the Fed last met, analysts broadly expect the central bank's quarterly economic projections to remain unchanged this week.

When those projections were last released in September, the Fed anticipated rates to fall to 3.6 per cent this year, before slowing the pace of cuts next year.

“This marks the end of a mini era,” Mr Tang said of the rate-cutting cycle.

Waiting in the wings to succeed Mr Powell is Kevin Hassett, a leading economic adviser of Mr Trump and economist behind the Abraham Accords. Mr Hassett has consistently pushed for lower rates in line with Mr Trump's demands, and has been a vocal critic of the Powell Fed.

Looming decisions from the Supreme Court will have major implications for the Federal Reserve. Bloomberg

But Mr Hassett's expected nomination is not the only change facing the Fed next year. A new rotating corps of regional Fed presidents will be seated, as Treasury Secretary Scott Bessent presses for more reforms among the 12 districts as part of the White House's latest push to exert control over the central bank.

Mr Trump said he will nominate Mr Powell's successor “early next year”.

The Supreme Court is also expected to have a major influence on Fed policy in 2026, with expected decisions on the legality of Mr Trump's emergency tariffs and his attempted sacking of Fed governor Lisa Cook.

Big-box retailer Costco became the latest company to sue the Trump administration last week, arguing that it is owed a refund because the President overstepped his authority through his sweeping tariffs.

Still to be decided is the fate of Mr Powell, whose tenure as Fed chair ends in May. Mr Powell can remain on the board as a Fed governor until 2038, but he has so far remained silent over his future.