The Federal Reserve meets on Wednesday, and last week’s hotter inflation data made the rate cut decision a bit more complicated. Meanwhile, economic data remains resilient, with the most recent estimate of fourth-quarter GDP growth from the Atlanta Federal Reserve at 3.3%.
Consumer inflation (CPI) ticked up to 2.7% year-over-year from 2.6% in October, consistent with expectations. Producer inflation (PPI) was above consensus at 3.0%, up from 2.6% previously. In both cases, inflation has remained sticky and above the 2% level.
The Case Against A December Fed Rate Cut
Recent headline CPI readings have been accelerating, with the three-month annualized rate running at 2.8%, likely making some Fed voters nervous about a resurgence in inflation.
The recent upward trend in inflation has also affected core CPI, excluding food and energy. Annualizing the last 3 months, the core CPI ran at a hot 3.7%.
Though it will be released after the Fed’s decision, the Fed’s preferred measure of inflation, the core PCE price index, should be at 2.9% year-over-year for November, which is well above the 2% target rate.
The Case For A December Fed Rate Cut
While some other components of inflation might be stickier than expected, the Fed should be very confident that the rate of housing inflation should continue to moderate. Like Zillow, real-time measures of rent inflation point to downward pressure on the government’s lagging measure of rent inflation. Shelter inflation is 36.6% of the CPI measurement, which is meaningful.
While the last payroll report was solid on the surface, there were some cracks, such as the unemployment rate ticking up to 4.2% from 4.1%. Before the decline from the August unemployment rate highs, the rate had risen enough off the lows to signal an impending recession by the Sahm Rule. The Sahm Rule has an unblemished track record of forecasting recession, but there are several reasons to believe that it might be overstating the risk of recession during this cycle. Notably, another slight move upward in the unemployment rate will push the Sahm Rule back onto forecasting an economic downturn.
Fed members are likely to focus on the softening of the labor market as a downside risk to the economy. The high-frequency initial and continuing filings for unemployment benefits are above early-year levels, illustrating the rising risk to the employment outlook.
The Federal Reserve began this easing cycle because monetary policy was too tight for the economic conditions. Looking at the real (after-inflation) level of the Federal Funds rate, monetary policy remains restrictive. This situation will likely convince Fed participants to vote for a rate cut as insurance against the downside economic risks at the Wednesday meeting.
December Fed Rate Cut Followed By A Pause
Despite the sticky inflation data, futures pricing agrees with the analysis with over 90% odds of 25 (0.25%) basis points at the Fed meeting this week. The most significant change has been a reduction in the pace of rate cuts in 2025. The elevated inflation readings and resilient economy point to the Fed pausing rate cuts at the January 29th meeting to await more evidence of economic trends.
While the rate cut on Wednesday won’t surprise markets, the Fed will update their forecasts. Those forecasts and Chair Powell’s comments will be parsed closely to judge the future pace of easing monetary policy but should include increased inflation and economic growth estimates.
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This week will be full of economic releases ahead of the slower Christmas holiday week. Retail sales on Tuesday will be particularly crucial in judging the resilience of the consumer, but the main event will likely be Wednesday’s Federal Reserve meeting. Despite inflation remaining stickier than many would like, the Fed will almost surely cut short-term interest rates again. Stocks are in the midst of the most favorable time of the year, so the seasonals add some comfort that last week’s decline shouldn’t prove to be the start of a significant decline.
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