December Rate-Cut Odds Fall as the Split Among Fed Officials Widens

Federal Reserve Chair Jerome Powell warned last month that the central bank is “driving in the fog” due, in part, to a dearth of government data during the shutdown. (Alex Wong/Getty Images)

Earlier this fall, it looked as if the Federal Reserve had mapped out the last stretch of its easing campaign for the year. The September Summary of Economic Projections, a compilation of Fed officials’ interest-rate and economic forecasts, pointed—albeit narrowly—to the equivalent of three quarter-point rate cuts by year end. The Fed delivered two in September and October, making December the obvious landing spot for the third.

Yet Fed Chair Jerome Powell’s warning in October that policymakers were “driving in the fog” reflected more than the government shutdown, which eventually stretched to 43 days. Even as federal agencies delayed the publication of economic data that help guide the Fed’s policy moves, the debate about rate cuts inside the Fed began to shift. Markets now see less than a 50% chance of a December cut, compared with the near-certainty priced in last month.

What happened?

More Fed officials have begun to see the risk of persistent inflation as greater than that of a cooling labor market, a change from earlier this year.

Through late summer, policymakers appeared more focused on the possibility of a labor slowdown. Hiring had moderated, wage gains were uneven, and the postpandemic excess demand for workers was ebbing. Recently, concerns about inflation, which remains about a percentage point above the Fed’s 2% annual target, and the risk that easing too quickly could stall the disinflation process, have grown more prominent.

“Close calls no longer go to the doves. Close calls probably go to the hawks now,” says Neil Dutta, head of economic research at Renaissance Macro Research.

December will be the first real test of that presumed shift.

The doves, who favor easier monetary policy, had plenty of reason for optimism just a few months ago. President Donald Trump’s appointments to the Fed’s board of governors leaned toward lowering interest rates, which other Fed officials justified based on cooling labor demand.

The combination of delayed economic data, firmer inflation readings, and the economy’s headline resilience has since complicated the picture. “Lacking fresh economic data, markets have become increasingly jittery in recent weeks,” says Seema Shah of Principal Asset Management.

Although the government shutdown ended Wednesday night, the economic-release calendar will remain uneven, and several reports may never be produced. That leaves the Fed to make an interest-rate decision at its December meeting with fewer signals than usual. Under these circumstances, Powell may be pushed into a compromise, says Thierry Wizman, a strategist at Macquarie, in which the Fed either “stays on hold in December or, if it does cut, is obligated subsequently to signal that the rate-cutting cycle may be over.”

Inside the Fed, the divide continues to grow. Boston Fed President Susan Collins, a voting member this year on the Federal Open Market Committee, has questioned the need for a third cut. “Absent evidence of a notable labor market deterioration, I would be hesitant to ease policy further,” she said in a recent speech, stressing that she sees “several reasons to have a relatively high bar for additional easing in the near term.”

Policy remains mildly restrictive, Collins said, and further cuts risk slowing the return of inflation to target just as tariffs are lifting the price of goods.

The September consumer price index showed that inflation rose 3% for the year, the highest level seen since January.

Cleveland Fed President Beth Hammack, a voting member next year who supported the October rate cut, is also signaling caution. “I see monetary policy as barely restrictive, if at all, and it’s not obvious to me that monetary policy should do more at this time,” she said this month.

Created with Highcharts 9.0.1So Much for That 2% TargetThe consumer price index for September, the latest government inflation reading,​showed 3% inflation for the year, the highest level since January.Consumer Price Index 12-month percentage changeSource: Bureau of Labor Statistics, U.S. Department of Labor

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Atlanta Fed President Raphael Bostic, who will retire early next year, framed the moment as “the most challenging environment” since he joined the Fed in 2017. Still, he said that “the clearer and urgent risk is still price stability.”

Bostic favors keeping rates steady “until we see clear evidence that inflation is again moving meaningfully toward its 2% target.”

“You’ll have a bunch of voters potentially lining up against a cut in December,” said Dutta.

St. Louis Fed President Alberto Musalem, voting this year, warned there is “limited room” for further easing. Chicago Fed President Austan Goolsbee, also a voting member, said his “threshold for cutting is a little bit higher than it was at the last two meetings.”

And Kansas City’s Jeffrey Schmid, who dissented in October in favor of no cut, said on Friday, “I don’t think we have room to be complacent,” on price increases. “History has shown us that persistent inflation can shift the psychology around price-setting, and inflation can become ingrained,” he said. “Were that to occur, re-anchoring inflation at 2% would be more difficult and costly. It is unlikely that we will still be talking about soft landings in that situation.”

Fed governor Michael Barr also emphasized the need for a cautious approach at the next meeting.

While the labor market is cooler than in early 2023, unemployment remains relatively low, and labor supply and demand look to be in balance, although both are weaker than in the past. Structural forces—reduced immigration, demographic pressures, and the deployment of artificial intelligence—are all at play. These changes raise costs and reduce hiring without necessarily signaling a collapse in labor demand. Rate cuts aren’t the fix for these developments.

To be sure, the doves still have a case for cutting rates. Fed governors such as Stephen Miran, Christopher Waller, and Michelle Bowman have argued in recent weeks that another cut is warranted to prevent policy from becoming unintentionally restrictive. They point to cooler hiring, softer wage growth, and the hit to interest-sensitive sectors from higher borrowing costs.

The doves also note that disinflation has progressed steadily since the consumer price index peaked around 9% in 2022, and that tariffs haven’t pushed prices as high as previously predicted.

At the same time, a widening divide between higher-income and lower-income households complicates the Fed’s mandate. Shah warns that “the economy’s resilience also hides a growing divide across income groups,” with higher-income households supported by equity wealth and lower-income families facing tighter credit, stagnant wages, and tariff-driven price pressures.

Fed officials have much to weigh at their December meeting. Inflation has been stuck above target for nearly five years, and the labor market is softening in uneven and sometimes painful ways. But for now, many policymakers seem more worried about doing too much than too little.

In a fog, standing still can feel like the safest move.

Write to Nicole Goodkind at nicole.goodkind@barrons.com.