WASHINGTON — No one knows how Tuesday’s presidential election will play out, but the Federal Reserve’s action two days later is much easier to predict: The Fed remains committed to cutting interest rates for a second time in a two-year period.
The presidential race may still not be resolved when the Fed concludes its two-day meeting Thursday afternoon, but that uncertainty would not affect its decision to cut its benchmark rate further. The Fed’s future actions, however, will become more uncertain once a new president and Congress take office in January, especially if Donald Trump wins the White House again.
Trump’s proposals to impose high tariffs on all imports and launch mass deportations of illegal immigrants, and his threats to infringe on the Fed’s normally independent rate decisions, could boost inflation, economists say. Higher inflation, in turn, would force the Fed to slow or halt its rate cuts.
On Thursday, Fed policymakers, led by Chairman Jerome Powell, are on track to cut their benchmark interest rate by a quarter point to around 4.6%, after cutting it by half a point in September. Economists expect another quarter-point cut in December and possibly more such cuts next year. Over time, interest rate cuts typically lower the cost of borrowing for consumers and businesses.
The Fed is cutting interest rates for a different reason than usual: It often cuts rates to stimulate a sluggish economy and weak labor market by encouraging more borrowing and spending. But the economy is growing strongly and so is the unemployment rate, a low 4.1%, the government reported Friday, even with hurricanes and a Boeing strike that severely depressed net job growth last month.
Instead, the central bank is cutting rates as part of what Powell called a “recalibration” toward a lower-inflation environment. When inflation peaked in June 2022 at a 40-year high of 9.1%, the Fed raised interest rates 11 times, ultimately bringing the benchmark rate to about 5.3%, also the highest in 40 years.
But by September, inflation had fallen to an annual rate of 2.4%, barely above the Fed’s 2% target and flat with 2018 levels. With inflation down so far, Powell and other Fed officials have said they believe high interest rates are no longer necessary. High rates tend to limit growth, especially in interest-rate-sensitive sectors like housing and auto sales.
“The constraint was there because inflation was high,” said Claudia Sahm, chief economist at New Century Advisors and a former Fed economist. “Inflation is no longer high. The reason for the constraint is gone.”
Fed officials have suggested that their rate cuts would be gradual. But nearly all have voiced support for further cuts.
“For me, the key question is how much and how quickly we should lower the target for the (key) rate, which I think is currently set at a restrictive level,” Christopher Waller, a prominent member of the Fed’s board of governors, said in a speech last month.
Jonathan Pingle, an economist at Swiss bank UBS, said Waller’s formulation reflected “unusual confidence and belief that interest rates would come down.”
Next year, the Fed will likely wrestle with exactly how low to set benchmark rates. Ultimately, it may want to set them at a level that neither restricts nor stimulates growth — “neutral” in the Fed’s jargon.
Powell and other Fed officials acknowledge that they don’t know exactly where the neutral rate is. In September, the Fed’s interest rate committee pegged it at 2.9%. Most economists believe it’s closer to 3% to 3.5%.
The Fed chairman said officials should judge where neutral is based on how the economy responds to rate cuts. For now, most officials are confident the Fed’s current rate is well above the neutral rate, at 4.9%.
Some economists, however, argue that with the economy looking healthy, even with high interest rates, the Fed doesn’t need to ease lending much, if at all. The idea is that they may already be close to the rate level that neither slows nor stimulates the economy.
“If the unemployment rate stays in the low 40s and the economy is still growing at 3%, does it matter that the (Fed) rate is 4.75% to 5%?” asked Joe LaVergne, chief economist at SMBC Nikko Securities. “Why are they cutting now?”
With the Fed’s final meeting just after Election Day, Powell is likely to answer questions about the outcome of the presidential election and how it could affect the economy and inflation during his press conference on Thursday. He can be expected to reiterate that the Fed’s decisions are not influenced by politics at all.
During Trump’s presidency, he imposed tariffs on washing machines, solar panels, steel and a range of goods from China, which President Joe Biden has maintained. While research shows that the tariffs raised the price of washing machines, overall inflation did not rise much.
But Trump is now proposing significantly broader tariffs — essentially import taxes — that would raise the price of about 10 times as many goods from abroad.
Many mainstream economists are alarmed by Trump’s latest proposed tariffs, which they say would almost certainly fuel inflation. A report from the Peterson Institute for International Economics found that Trump’s key tariff proposals would push inflation 2 percentage points higher next year than it otherwise would have been.
Economists at Pantheon Macroeconomics said the Fed would be more likely to raise rates in response to the tariffs “because Trump is threatening much larger rate hikes.”
“As a result,” they wrote, “we will scale back the funds rate cut in our 2025 forecasts if Trump wins.”