Expectation of Interest Cut by 0.25 Points

The Federal Open Market Committee (FOMC) of the Federal Reserve (Fed) meets this Tuesday, 28th, and tomorrow to decide whether to reduce key interest rates again, with analysts predicting a cut of 25 percentage points.

If the decline is confirmed, it will be the second time this year that key interest rates, currently between 4% and 4.25%, have been changed.

The budget impasse (‘shutdown’) in the United States, which appears to be far from being resolved, has blocked the release of many statistical data, especially indicators relating to unemployment and the personal consumption price index (PCE) — the one to which the Fed pays the most attention to conduct its monetary policy.

Without updated data, it becomes more difficult for the Fed to determine the true state of the American economy, especially with regard to fulfilling its dual mandate: achieving full employment and limiting the rise in inflation to 2% per year.

The US job market has shown signs of slowing down, particularly in new hiring, which is seen as a risk to the economy. Some analysts indicate that only the drastic drop in migration flows prevented the increase in unemployment, which reached 4.3% in August – the last month for which data is available.

But unemployment and inflation may not be the Federal Reserve’s only challenges, according to KPMG chief economist Diane Swonk, cited by AFP.

“The Fed must also manage the issue of liquidity in financial markets as it tries to manage its significantly expanded balance sheet,” Swonk stresses. If there is a risk of an economic slowdown, a central bank can initiate quantitative easing and purchase assets in the markets to inject liquidity.

After opting for this action during the 2008 financial crisis and during the Covid-19 pandemic, the Fed began a phase of monetary tightening (‘quantitative tightening’), withdrawing liquidity and returning part of the acquired assets to the market.

Michael Krautzberger, an analyst at AllianzGI, agrees that the debate about the end of quantitative tightening should gain strength by the end of this year, and that the reduction of the Fed’s balance sheet should be completed by the first quarter of next year.

“This would mean a shift towards more accommodative liquidity conditions, which would reduce pressure on funding markets”, considers Florian Späete, analyst at Generali AM, predicting that an early end to quantitative tightening and a consequent improvement in liquidity allow for the prospect of “a soft landing for the US economy, as the eurozone moves towards a gradual recovery”.

After a nine-month pause, the Fed resumed the rate cutting cycle in September, placing greater focus on its full employment mandate. President Jerome Powell described the measure as a “cut in risk management”, easing monetary policy to mitigate the potential risks of a fall in the job market, despite inflation remaining high.

The Federal Open Market Committee (FOMC) is made up of 12 members: the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York and four of the remaining 11 presidents of the Reserve Bank, who serve one-year terms on a rotating basis.