Economics

The Fed is on course to cut interest rates in December, but what happens next is anyone’s guess

Published

3 months ago

December 7, 2024

Jerome Powell, chairman of the US Federal Reserve, during the New York Times DealBook Summit at Jazz at Lincoln Center in New York, US, on Wednesday, Dec. 4, 2024.

Yuki Iwamura | Bloomberg | Getty Images

Friday’s jobs report virtually cements that the Federal Reserve will approve an interest rate cut when it meets later this month. Whether it should, and what it does from there, is another matter.

The not-too-hot, not-too-cold nature of the November nonfarm payrolls release gave the central bank whatever remaining leeway it may have needed to move, and the market responded in kind by raising the implied probability of a reduction to close to 90%, according to a CME Group gauge.

However, the central bank in the coming days is likely to face a vigorous debate over just how fast and how far it should go.

“Financial conditions have eased massively. What the Fed runs the risk of here is creating a speculative bubble,” Joseph LaVorgna, chief economist at SMBC Nikko Securities, speaking on CNBC’s “Squawk Box,” said after the report’s release. “There’s no reason to cut rates right now. They should pause.”

LaVorgna, who served as a senior economist during Donald Trump’s first presidential term and could serve in the White House again, wasn’t alone in his skepticism about a Fed cut.

Chris Rupkey, senior economist at FWDBONDS, wrote that the Fed “does not need to be tinkering with measures to boost the economy as jobs are plentiful,” adding that the central bank’s stated intention to keep reducing rates looks “to be increasingly unwise as the inflation fire has not been put out.”

Appearing along with LaVorgna on CNBC, Jason Furman, himself a former White House economist under Barack Obama, also expressed caution, particularly on inflation. Furman noted that the recent pace of average hourly earnings increases is more consistent with an inflation rate of 3.5%, not the 2% the Fed prefers.

“This is another data point in the no-landing scenario,” Furman said of the jobs report, using a term that refers to an economy in which growth continues but also sparks more inflation.

“I’ve no doubt the Fed will cut again, but when they cut again after December is anyone’s guess, and I think it will take more of an increase in unemployment,” he added.

Factors in the decision

In the interim, policymakers will have a mountain of information to plow through.

To start: November’s payrolls data showed an increase of 227,000, slightly better than expected and a big step up from October’s paltry 36,000. Adding the two month’s together — October was hampered by Hurricane Milton and the Boeing strike — nets an average of 131,500, or slightly below the trend since the labor market first started to wobble in April.

But even with the unemployment rate ticking up 4.2% amid a pullback in household employment, the jobs picture still looks solid if not spectacular. Payrolls still have not decreased in a single month since December 2020.

There are other factors, though.

Inflation has started ticking up lately, with the Fed’s preferred measure moving up to 2.3% in October, or 2.8% when excluding food and energy prices. Wage gains also continue to be robust, with the current 4% easily surpassing the pre-Covid period going back to at least 2008. Then there’s the issue of Trump’s fiscal policy when he begins his second term and whether his plans to issue punitive tariffs will stoke inflation even further.

In the meantime, the broader economy has been growing strongly. The fourth quarter is on track to post a 3.3% annualized growth rate for gross domestic product, according to the Atlanta Fed.

Then there’s the issue of “financial conditions,” a metric that includes such things as Treasury and corporate bond yields, stock market prices, mortgage rates and the like. Fed officials believe the current range in their overnight borrowing rate of 4.5%-4.75% is “restrictive.” However, by the Fed’s own measure, financial conditions are at their loosest since January.

Earlier this week, Fed Chair Jerome Powell praised the U.S. economy, calling it the envy of the developed world and said it provided cushion for policymakers to move slowly as they recalibrate policy.

In remarks Friday, Cleveland Fed President Beth Hammack noted the strong growth and said she needed more evidence that inflation is moving convincingly toward the Fed’s 2% goal. Hammack advocated for the Fed to slow down its pace of rate cuts. If it follows through on the December reduction, that will equate to a full percentage point move lower since September.

Looking for neutral

“To balance the need to maintain a modestly restrictive stance for monetary policy with the possibility that policy may not be far from neutral, I believe we are at or near the point where it makes sense to slow the pace of rate reductions,” said Hammack, a voting member this year on the Federal Open Market Committee.

The only thing left on the docket that could dissuade the Fed from a December cut is the release next week of separate reports on consumer and producer prices. The consumer price index is projected to show a 2.7% gain. Fed officials enter their quiet period after Friday when they do not deliver policy addresses before the meeting.

The issue of the “neutral” rate that neither restricts nor boosts growth is central to how the Fed will conduct policy. Recent indications are that the level may be higher than it has been in previous economic climates.

What the Fed could do is enact the December cut, skip January, as traders are anticipating, and maybe cut once more in early 2025 before taking a break, said Tom Porcelli, chief U.S. economist at PFIM Fixed Income.

“I don’t think there’s anything in today’s data that would actually stop them from cutting in December,” Porcelli said. “When they lifted rates as much as they did, it was for a completely different inflation regime than we have right now. So in that context, I think Powell would like to continue the process of normalizing policy.”

Powell and his fellow policymakers say they are now casting equal attention on controlling inflation and supporting the labor market, whereas previously the focus was much more on prices.

“If you want until you see cracks from a labor market perspective and then you start to adjust policy down, it’s too late,” he said. “So prudence would really suggest that you start that process now.”

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Economics

Germany’s election will usher in new leadership — but might not change its economy

Published

1 day ago

February 21, 2025

Business Finance News

Production at the VW plant in Emden.

Sina Schuldt | Picture Alliance | Getty Images

The struggling German economy has been a major talking point among critics of Chancellor Olaf Scholz’ government during the latest election campaign — but analysts warn a new leadership might not turn these tides.

As voters prepare to head to the polls, it is now all but certain that Germany will soon have a new chancellor. The Christian Democratic Union’s Friedrich Merz is the firm favorite.

Merz has not shied away from blasting Scholz’s economic policies and from linking them to the lackluster state of Europe’s largest economy. He argues that a government under his leadership would give the economy the boost it needs.

Experts speaking to CNBC were less sure.

“There is a high risk that Germany will get a refurbished economic model after the elections, but not a brand new model that makes the competition jealous,” Carsten Brzeski, global head of macro at ING, told CNBC.

The CDU/CSU economic agenda

The CDU, which on a federal level ties up with regional sister party the Christian Social Union, is running on a “typical economic conservative program,” Brzeski said.

It includes income and corporate tax cuts, fewer subsidies and less bureaucracy, changes to social benefits, deregulation, support for innovation, start-ups and artificial intelligence and boosting investment among other policies, according to CDU/CSU campaigners.

“The weak parts of the positions are that the CDU/CSU is not very precise on how it wants to increase investments in infrastructure, digitalization and education. The intention is there, but the details are not,” Brzeski said, noting that the union appears to be aiming to revive Germany’s economic model without fully overhauling it.

“It is still a reform program which pretends that change can happen without pain,” he said.

Geraldine Dany-Knedlik, head of forecasting at research institute DIW Berlin, noted that the CDU is also looking to reach gross domestic product growth of around 2% again through its fiscal and economic program called “Agenda 2030.”

But reaching such levels of economic expansion in Germany “seems unrealistic,” not just temporarily, but also in the long run, she told CNBC.

Germany’s GDP declined in both 2023 and 2024. Recent quarterly growth readings have also been teetering on the verge of a technical recession, which has so far been narrowly avoided. The German economy shrank by 0.2% in the fourth quarter, compared with the previous three-month stretch, according to the latest reading.

Europe’s largest economy faces pressure in key industries like the auto sector, issues with infrastructure like the country’s rail network and a housebuilding crisis.

Dany-Knedlik also flagged the so-called debt brake, a long-standing fiscal rule that is enshrined in Germany’s constitution, which limits the size of the structural budget deficit and how much debt the government can take on.

Whether or not the clause should be overhauled has been a big part of the fiscal debate ahead of the election. While the CDU ideally does not want to change the debt brake, Merz has said that he may be open to some reform.

“To increase growth prospects substantially without increasing debt also seems rather unlikely,” DIW’s Dany-Knedlik said, adding that, if public investments were to rise within the limits of the debt brake, significant tax increases would be unavoidable.

“Taking into account that a 2 Percent growth target is to be reached within a 4 year legislation period, the Agenda 2030 in combination with conservatives attitude towards the debt break to me reads more of a wish list than a straight forward economic growth program,” she said.

Change in German government will deliver economic success, says CEO of German employers association

Franziska Palmas, senior Europe economist at Capital Economics, sees some benefits to the plans of the CDU-CSU union, saying they would likely “be positive” for the economy, but warning that the resulting boost would be small.

“Tax cuts would support consumer spending and private investment, but weak sentiment means consumers may save a significant share of their additional after-tax income and firms may be reluctant to invest,” she told CNBC.

Palmas nevertheless pointed out that not everyone would come away a winner from the new policies. Income tax cuts would benefit middle- and higher-income households more than those with a lower income, who would also be affected by potential reductions of social benefits.

Coalition talks ahead

Following the Sunday election, the CDU/CSU will almost certainly be left to find a coalition partner to form a majority government, with the Social Democratic Party or the Green party emerging as the likeliest candidates.

The parties will need to broker a coalition agreement outlining their joint goals, including on the economy — which could prove to be a difficult undertaking, Capital Economics’ Palmas said.

“The CDU and the SPD and Greens have significantly different economic policy positions,” she said, pointing to discrepancies over taxes and regulation. While the CDU/CSU want to reduce both items, the SPD and Greens seek to raise taxes and oppose deregulation in at least some areas, Palmas explained.

The group is nevertheless likely to hold the power in any potential negotiations as it will likely have their choice between partnering with the SPD or Greens.

“Accordingly, we suspect that the coalition agreement will include most of the CDU’s main economic proposals,” she said.