Will the Fed cut rates again next week?

The US Federal Reserve has a dual mandate. Its goal is to keep the Consumer Price Index (CPI), a measure of inflation, at a rate of 2% per year, and it also seeks to maintain full employment in the economy (although there is no specific target for the unemployment rate) .

If the CPI deviates too far from 2% or there is a dramatic change in the labor market, the Fed will raise or lower the federal funds rate (also called the federal funds rate) to influence economic activity.

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At its September meeting, the Federal Open Market Committee (FOMC) decided to cut the key interest rate by half a percentage point. The November FOMC meeting is scheduled for next Wednesday and Thursday. So is another cut on the table?

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In 2022, the CPI rose to a 40-year high of 8%. There were a number of factors that contributed to this:

In 2020 and 2021, the US government pumped trillions of dollars into the economy to offset the negative impact of the COVID-19 pandemic.
For the same reason, the Fed cut interest rates to a historic low of almost 0% in March 2020. Additionally, it has pumped trillions of dollars into the financial system through quantitative easing (QE).
COVID-19 caused factories to close worldwide, leading to a shortage of consumer goods and a rise in prices.

This inflation cocktail triggered a decisive response from the Fed. It raised the key interest rate to its highest level in two decades of 5.33% in 18 months, with the last increase coming in August 2023.

Fortunately, this political adjustment worked. The CPI was 4.1% in 2023 and has fallen further to an annual rate of just 2.4% after the most recent value in September 2024. For this reason, the Fed decided that it was appropriate to cut interest rates by 50 basis points (one basis point equal to 0.01 percentage points) at its last meeting.

It seems very likely that another rate cut is coming next week as inflation is clearly trending toward the Fed's 2% target. Additionally, the unemployment rate has risen from 3.7% to 4.1% this year, suggesting that there may be some weakness in the labor market.

Fed Chairman Jerome Powell recently said downside risks to employment have increased, meaning further rate cuts are likely warranted to support economic growth before there is further deterioration.

According to the FOMC's September forecast, the key interest rate could fall by another 50 basis points by the end of 2024. With only the November and December meetings remaining, the most likely outcome is two cuts of 25 basis points each.

That's exactly it CME GroupFedWatch's FedWatch tool forecasts. This suggests that there is a 95% chance of a 25 basis point cut at next week's meeting, followed by a 78% chance of another cut of the same amount in December.

The FOMC forecast suggests there could be another 125 basis points worth of cuts in 2025, with a final cut of 25 basis points in 2026. This could push the federal funds rate to 2.88%, a decline of almost would be half of its recent peak.

Lower interest rates are typically good for the stock market in the long run. Companies can borrow more money to fuel their growth and their interest costs are lower, which has a direct positive impact on their earnings. Lower interest rates also put more money in consumers' pockets to spend throughout the economy.

However, there is a caveat. Investors don't want interest rates to fall due to an economic distress (such as a pandemic or financial crisis) because that would weigh on company profits and lead to lower stock prices. That's nothing to worry about right now, but it's a good idea to keep an eye on the unemployment rate – if it continues to rise, it could be a sign of trouble on the horizon.

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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.

Will the Fed cut rates again next week? was originally published by The Motley Fool

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