The US Federal Reserve Board is in the dark, there are mixed signals from the US economy, members of its rate-setting committee are increasingly divided and Donald Trump’s pick for its next chair will soon be revealed.
All of these developments have created a number of question marks over the outlook for US monetary policy.
In announcing a 25 basis cut to its policy rate, the federal funds rate (equivalent to the Reserve Bank’s cash rate), Fed chair Jerome Powell said there were divided views on what the US central bank should do next.
“Policy is not on a preset course,” Jerome Powell has warned financial markets.Credit: AP
“At this meeting, there were strongly differing views about how to proceed. A further reduction in the policy rate at the December meeting is not a foregone conclusion,” he warned.
“Far from it. Policy is not on a preset course. And the takeaway from that is that we haven’t made a decision about December.”
Before this week’s meeting of the Fed’s Open Market Committee, which sets US monetary policy, financial markets were pricing in a more than 90 per cent probability that there would be another 25 basis point rate cut in December. After Powell’s comments, that fell below 70 per cent.
‘What do you do if you’re driving in the fog? You slow down.’
Fed chair Jerome Powell
A contributing factor to the Fed’s indecision is the absence of data. The shutdown of the US federal government, now into its fourth week and the second-longest shutdown in history (the longest was a 35-day partial shutdown during Donald Trump’s first term), means there is little official economic data available to guide the central bank’s decision-making.
Last week’s inflation data for September, which showed US inflation running at 3 per cent — well above the Fed’s target of 2 per cent — for instance, was only available because the Bureau of Labor Statistics called in a handful of furloughed staff. The Trump administration has said it is unlikely that the data for October will be compiled if the shutdown continues.
Without data on inflation and unemployment – the two key metrics the Fed needs to manage with its dual mandate of maximising employment while maintaining stable prices – its policymakers are flying blind, which Powell conceded might influence the outcome of the December meeting.
“What do you do if you’re driving in the fog? You slow down,” he said.
“I’m not committing to that. I’m just saying it’s certainly a possibility that you would say ‘we really can’t see. So let’s slow down.’”
Even leaving aside the impact of the dearth of data for an institution that prides itself on being data-driven, there would be no certainty of a December cut.
The decision to trim the federal funds rate by 25 basis points, the second rate cut this year, wasn’t unanimous.
Trump’s man inside the Fed, Stephen Miran, who may be warming the seat for Trump’s nominee to succeed Powell when he is scheduled to retire next May, voted for a 50 basis point cut for the second time in the two meetings he has attended. Kansas City Fed president Jeffrey Schmid voted for no change and Powell indicated there were others who would like the Fed to move cautiously.
“For some part of the committee, it’s time to maybe take a step back and see whether there really are downside risks to the labour market, or see whether in fact, the stronger growth that we’re seeing is real,” he said.
‘A further reduction in the policy rate at the December meeting is not a foregone conclusion. Far from it.’
Fed chair Jerome Powell
Complicating the Fed’s task is that, while America’s unemployment rate was rising (despite Trump’s Draconian immigration policies that are shrinking the pool of available labour) before the shutdown’s data blackout, so is inflation, as the impact of his tariffs slowly bleeds through into prices that, since mid-year, have been steadily edging up with each release of the inflation data.
A slew of big job cuts in recent days from companies like Amazon, UPS, General Motors, Intel, Nestle, Target and ConocoPhillips isn’t going to help the jobs market, while the rundown of pre-tariff inventories should be almost exhausted and the impact of the tariffs on inflation should become progressively clearer.
The government shutdown will also have an impact of the economy, with hundreds of thousands of government employees stood down without pay and the administration withholding funds from some programs where Congress had previously approved funding.
The Congressional Budget Office said this week that the shutdown could cost the US economy up to $US14 billion ($21 billion) and lower December quarter GDP by one or two percentage points. While some of those impacts will be reversed when government re-opens, the longer the shutdown lasts the more permanent the losses will be.
Those are the key elements that created the fog Powell referred to, but there’s also the massive investments pouring into artificial intelligence that are propping up US growth, but disguising what’s happening in the rest of the economy, where there’s an element of bifurcation: AI companies and wealthier households exposed to the sharemarket and favoured by the tax cuts within Trump’s One Big Beautiful Bill seem to be prospering, but lower-income households are experiencing increasing stress.
The levels of stress and the complexity of the settings that the Fed, which doesn’t have the tools to target different demographic groups, finds itself in, will mount further as new health insurance premiums take effect from this weekend, with big price hikes as a result of the One Big Beautiful Bill’s cuts to healthcare funding – unless the Democrats force changes as the quid pro quo for ending the shutdown.
The recent disharmony within the Fed, which has long tended to produce unanimous voting outcomes, adds another layer of uncertainty.
It became evident in its September meeting that, leaving aside Miran’s obvious interest in advocating for the bigger rate cuts that Trump has consistently demanded, an unusual divergence of views has developed within the 19-member Open Market Committee.
At that meeting, about half the members (excluding Miran) expected two more 25 basis point rate cuts this year, two expected only one and seven expected none.
The hawkish tone Powell adopted when talking about the prospect of a rate cut in December suggests the size of the faction arguing for no further cuts this year might have swollen, which would displease Trump.
If, as foreshadowed, Treasury Secretary Scott Bessent hands the name of his recommended nominee to succeed Powell to Trump late next month, there will also be a larger political dimension to the Fed’s decision-making.
Those on the shortlist – current Fed governors Christopher Waller and Michelle Bowman, the director of the White House economic council Kevin Hassett, former Fed governor Kevin Warsh and Black Rock executive Rick Rieder – would effectively become the shadow chair, with the capacity to distract and confuse as financial market participants try to determine what the Fed’s policies will look like next year.
The key criteria Trump wants from Powell’s successor is a commitment to significantly lowering US rates, almost regardless of the economic circumstances.
This week’s rate cut was the primary focus for financial markets, but the Fed also announced the end, from December 1, of its quantitative tightening program, which allowed Treasury and mortgage-backed securities it had bought to boost liquidity and lower rates during the pandemic to mature without reinvesting the proceeds.
The size of the Fed’s balance sheet peaked at just under $US9 trillion in 2022. It’s now down to $US6.6 trillion and that draining of liquidity from financial markets has recently started to show up in tight liquidity and elevated funding costs in the short-term funding markets for banks.
The end of quantitative tightening, at least for the moment, also represents a punctuation point in an era of unconventional US monetary policies that started with quantitative easing – the purchases of those Treasury securities and mortgage-backed securities – in response to the global financial crisis in 2008 and the pandemic in 2020, and then morphed into quantitative tightening as those programs were gradually unwound.
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