The Fed has a big interest rate decision on Wednesday. Here’s what you can expect

Inflation is stubbornly above target, the economy is growing at around a 3% pace and the labor market remains strong. Put it all together and it sounds like a perfect recipe for the Federal Reserve to raise interest rates, or at least keep them going.

However, that is not what is likely to happen when the Federal Open Market Committee, the central bank’s rate-setting arm, publishes its policy decision on Wednesday.

Instead, futures market traders are pricing in a near certainty that the FOMC will actually cut its benchmark interest rate by a quarter of a percentage point, or 25 basis points. That would bring it down to a target range of 4.25% to 4.5%.

Even with the high level of market anticipation, it can be a decision that comes under an unusual level of scrutiny. A CNBC poll found that while 93% of respondents said they expect a cut, only 63% said it’s the right thing to do.

“I would be inclined to say ‘no cut,'” former Kansas City Fed President Esther George said Tuesday during a CNBC “Squawk Box” interview. “Let’s wait and see how the data comes in. Twenty-five basis points doesn’t usually make or break where we are, but I think it’s time to signal to the markets and the public that they haven’t taken their eye off inflation. ball.”

Indeed, inflation remains a burning issue for politicians.

While the annual rate has fallen significantly from its 40-year peak in mid-2022, it has hovered around the 2.5% to 3% range for most of 2024. The Fed is targeting 2% inflation.

The Commerce Department is expected to report Friday that the personal consumption expenditures price index, the Fed’s preferred inflation gauge, ticked higher in November to 2.5%, or 2.9% on the base reading that excludes food and energy.

Justifying a rate cut in that environment will require some deft communication from Chairman Jerome Powell and the committee. Former Boston Fed President Eric Rosengren also recently told CNBC that he would not cut at this meeting.

“They’re very clear about what their targets are, and as we see inflation data coming in, we see that it’s not continuing to slow down in the same way that it had in the past,” George said. “So that, I think, is a reason to be cautious and really think about how much of this easing of policy is required to keep the economy on track.”

Fed officials who have advocated for cuts say policy doesn’t need to be so restrictive in the current environment and they don’t want to risk hurting the labor market.

If the Fed follows through on the cut, it would mark a full percentage point cut from the federal funds rate since September.

While that’s significant easing in the short term, Fed officials have tools at their disposal to let markets know that future cuts won’t come so easily.

One of these tools is the dot-plot matrix of individual members’ expectations for prices over the next few years. It will be updated on Wednesday along with the rest of the summary of economic projections, which will include informal outlooks for inflation, unemployment and gross domestic product.

Another tool is the use of guidance in the post-meeting statement to indicate where the committee sees the policy going. Finally, Powell can use his press conference to provide further clues.

It is Powell’s engagement with the media that the markets will follow most closely, followed by dot plots. Powell recently said the Fed “can afford to be a little more cautious” about how quickly it eases amid what he characterized as a “strong” economy.

“We will see them lean into the direction of travel to begin the process of moving up their inflation forecast,” said Vincent Reinhart, BNY chief economist and former director of the Division of Monetary Affairs at the Fed, where he served for 24 years. “The dots (will) move up a bit and (there will be) a lot of preoccupation at the press conference with the idea of ​​skipping meetings. So it will turn out to be a hawkish cut in that regard.”

So far, the chairman and his colleagues have ignored questions about effect Trump’s initiatives could have on monetary policy, citing uncertainty about what is just talk now and what will later become reality. Some economists believe the incoming president’s plans for aggressive tariffs, tax cuts and mass deportations could worsen inflation even more.