Discussion of the Fed’s December cut has heated up, now with more data

Markets are very confused about whether the Fed will cut interest rates in December, with sharp division among Fed officials on that question playing out publicly.

One camp says cutting interest rates next month would help a labor market that is showing signs of weakness. The other says inflation remains above the Fed’s 2% target and sees more signs of economic strength.

Rather than clarifying the debate, the return of missing economic data that disappeared during the lockdown provides each side with more information. Each camp is making clear its leanings as the Fed’s December 9-10 meeting approaches.

“It is striking that both sides have compelling, high-conviction arguments – cut on the basis of cool business conditions or wait due to persistent inflation risks,” Ian Lingen, head of US interest rates strategy at BMO Capital Markets, wrote in a note to clients.

The long-awaited September report is “the perfect Rorschach test” for Fed officials, Matthew Luzetti, chief U.S. economist at Deutsche Bank, wrote in a note to clients. That is, their reading of the September report will likely depend on which camp they belong to.

Those hawkish will likely point to the addition of 119,000 jobs in September as a sign that the economy is not in decline. Alternatively, those in favor of monetary easing may point to the rising unemployment rate, which rose to 4.4% from 4.3% and is at its highest level since October 2021.

The public debate was a wild ride in markets’ views on Fed policy. Investors’ views of a near-certain December cut were tempered on October 29, when Federal Reserve Chairman Jerome Powell said a December cut was “not a foregone conclusion.”

By Thursday, traders saw a rate cut as unlikely. The probability of a Fed cut fell to 39%, according to CME Group’s FedWatch tool, which uses futures market pricing to gauge investor sentiment on Fed meetings.

However, on Friday, the chances of a rate cut rose again and now exceed 70%. The catalyst: A speech by New York Fed Chairman John Williams, who put himself in the dovish camp by saying he sees “room for further adjustment in the near term.”

The issue of doves

Williams’ vote is key because the New York Fed leader wields significant influence at FOMC meetings. He framed his view within the two goals Congress had set for the Federal Reserve: ensuring maximum employment and stable prices.

He acknowledged that the Fed’s progress toward lowering inflation to its 2% target had “paused a pause,” with inflation approaching 3% today.

But he added that “the upside risks to inflation have diminished somewhat,” expecting inflation to return to 2% in 2027.

While tariffs may continue to raise prices to some extent, there are no signs of “second round” effects or “large-scale supply chain bottlenecks” that could lead to a cycle of higher prices, he said.

While it is “essential to bring inflation back to our long-term target of 2%,” Williams said, it is equally important to avoid “creating undue risks to our maximum employment target” by keeping interest rates high.

Fed Governor Christopher Waller said this week — ahead of the September jobs report — that he supports a rate cut in December due to weak business conditions. He pointed to rising unemployment claims in state-level data and sluggish private sector jobs data for October.

“My focus is on the labor market, and after months of weakness, the September jobs report later this week or any other data in the next few weeks is unlikely to change my view that another cut is appropriate,” he said.

Falcons case

Other Fed officials appeared more likely to favor staying put, citing inflation as an ongoing risk.

“I’m concerned that we see inflation still at around 3% and our target is 2%,” Fed Governor Michael Barr said at an event Thursday, according to Bloomberg News. “So we have to be careful and cautious now on monetary policy, because we want to make sure that we achieve both aspects of our mission,” he added.

Progress toward inflation returning to 2% “appears to have stalled,” Chicago Fed President Austan Goolsbee said at a CFA Society event in Indianapolis.

“It makes me feel a little uncomfortable,” Goolsby said.

One of the Fed’s most hawkish voices has been above the Fed’s 2% target for more than four years, Cleveland Fed President Beth Hammack said Thursday.

“Cutting interest rates to support the labor market risks prolonging this period of high inflation, and could also encourage risk-taking in financial markets,” Hammack said.

Somewhere in between

There is still more data to come between now and December 10, with the delayed September retail sales report considered a key gauge of consumer spending.

“I expect to learn a lot between now and the next meeting,” Philadelphia Fed President Anna Paulson said Thursday.

Paulson said she was “a little more worried about the labor market than I am about inflation,” but kept her options open, noting that she was “approaching the December FOMC meeting cautiously.”

The Fed’s picture of the economy will also be less complete than usual, given the cancellation of official jobs and inflation reports in October. The November jobs report will also be released on December 16, later than usual and after the Federal Reserve meeting on December 9-10.

Given that September’s jobs report was stronger than expected, the Fed is likely to opt for a “dovish hold in December,” Michael Jaben, chief U.S. economist at Morgan Stanley, wrote in a note to clients.

This means interest rates will be kept unchanged in December, but there is a signal that further cuts are coming in 2026.