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Here’s Why the Fed Is Getting Cold Feet About Cutting Interest Rates

Last Updated September 23, 2020 1:01 PM
Sam Bourgi
Last Updated September 23, 2020 1:01 PM

Will the Federal Reserve cut interest rates after its meeting on Wednesday?

If you asked traders this question a few weeks ago, they would tell you with more than 95% certainty that another rate cut was happening in September. Now, the picture isn’t so clear.

Central Bankers Getting Cold Feet, Fed Fund Futures Imply

There’s still a pretty good chance that the Fed will lower interest rates on Wednesday. Markets are pricing in a more than 65% likelihood of that happening, according  to the latest Fed Fund futures prices from CME Group. But that figure is at least 30 percentage points lower than where we were earlier in the month when futures traders were all but certain that a second rate cut in as many meetings was on the way.

Fed fund futures
A second Fed rate cut isn’t as certain as it was before, according to CME futures. | Source: CME Group

Shifting attitudes toward monetary policy reflect a string of better than expected data releases showing higher inflation and a decent services sector. Consumer prices and wages rose faster than expected in August despite apparent weakness in other pockets of the economy, namely manufacturing.

U.S. Treasury yields also recorded their biggest weekly gain in at least three years, highlighting easing economic worries . As bond yields fell, the Dow and broader U.S. stock market surged back toward record highs.

Against this backdrop, there’s some evidence to suggest that the Federal Open Market Committee (FOMC) may adopt a more patient approach when setting monetary policy.

Assessing Economic Risks

donald trump, dow jones industrial average
President Trump is urging the Fed to ease monetary policy into uncharted territory. | Source: AP Photo / Evan Vucci

Although recent data are clouding our judgement about this week’s policy announcement, they’ve done very little to change the Fed’s mind about the economy.

The Fed turned dovish on monetary policy shortly after the December 2018 stock-market crash. The trend toward zero interest rates will likely accelerate as FOMC members join a chorus of central bankers around the world in easing monetary policy to accommodate a weaker economy and ongoing trade-war risks.

At the same time, the Fed is facing pressure from above, with President Donald Trump insisting that officials cut rates to zero or below.

The U.S. economy has seen diminishing returns since Trump’s first year in office but remains well ahead of its advanced peers abroad. Gross domestic product (GDP) expanded 2% annually in the second quarter, the second-weakest in three years. The economy expanded at a 3.1% annual clip between January and March.

FOMC Meeting Timeline

FOMC officials kick off their two-day policy meeting on Tuesday, with the official interest-rate decision coming the following afternoon. The Wednesday decision will be accompanied by a revised summary of economic projections covering GDP, unemployment and inflation.

After September, the Fed only has two policy meetings remaining for 2019 – one in October and one in December.