The Fed is on track to cut rates in December, but what will happen next remains to be seen

Friday's jobs report all but confirms that the Federal Reserve will approve a rate cut when it meets later this month. Whether it should, and what it does from there, is another matter.

The not-too-hot, not-too-cold nature of the November nonfarm payrolls release gave the central bank all the remaining headroom it needed to move, and the market responded in kind by predicting the implied likelihood of a reduction to nearly 90%, according to a CME Group poll.

However, the central bank is likely to face a fierce debate in the coming days about how fast and how far to go.

“Financial conditions have eased tremendously. What the Fed risks is creating a speculative bubble,” Joseph LaVorgna, chief economist at SMBC Nikko Securities, said on DailyExpertNews's “Squawk Box” after the report's release. “There is no reason to cut rates at this point. They should pause.”

LaVorgna, who served as a senior economist during Donald Trump's first presidential term and could serve in the White House again, wasn't the only one skeptical about a Fed cut.

Chris Rupkey, senior economist at FWDBONDS, wrote that the Fed “doesn't need to tinker with measures to stimulate the economy as there are plenty of jobs,” adding that the central bank's stated intention to keep cutting rates “seems to be increasingly unwise now that the inflation fire has not yet been extinguished.”

Jason Furman, himself a former White House economist under Barack Obama, appeared on DailyExpertNews with LaVorgna and also expressed caution, especially on inflation. Furman noted that the recent pace of increase in average hourly wages is more consistent with inflation of 3.5%, not the 2% preferred by the Fed.

“This is another data point in the no-landing scenario,” Furman said of the jobs report, using a term that refers to an economy in which growth continues but also leads to more inflation.

“I have no doubt that the Fed will cut again, but when they will cut again after December is anyone's guess, and I think a bigger increase in unemployment will be necessary,” he added.

In the meantime, policymakers will have to plow through a mountain of information.

For starters, November payrolls data showed an increase of 227,000, slightly better than expected and a big step up from October's paltry 36,000. Adding the two months together – October was hampered by Hurricane Milton and the Boeing strike – the average is 131,500, which is slightly lower than the trend since the labor market first began to falter in April.

But even as the unemployment rate has risen 4.2% and household employment has fallen, the jobs picture still looks solid, if not spectacular. Wages have still not fallen in a single month since December 2020.

However, there are other factors.

Inflation has been rising lately, with the Fed's preferred measure rising to 2.3% in October, or 2.8% if food and energy prices are excluded. Wage increases also remain robust, with the current 4% easily surpassing pre-Covid-19 levels dating back to at least 2008. Then there's the matter of Trump's fiscal policy as he begins his second term and whether his plans to introducing punitive taxes will also be effective. fuel inflation even further.

Meanwhile, the broader economy has grown strongly. According to the Atlanta Fed, the fourth quarter is on track to deliver annual gross domestic product growth of 3.3%.

Then there's the matter of 'financial conditions', a measure that includes things like government and corporate bond yields, share prices, mortgage rates and the like. Fed officials believe that their current overnight rate range of 4.5%-4.75% is “restrictive.” However, by the Fed's own measure, financial conditions are at their worst since January.

Earlier this week, Fed Chairman Jerome Powell praised the U.S. economy, calling it the envy of the developed world and saying it gave policymakers a cushion to move slowly in recalibrating policy.

In remarks Friday, Cleveland Fed President Beth Hammack noted the strong growth and said she needed more evidence that inflation is moving convincingly toward the Fed's 2% target. Hammack advocated for the Fed to slow the pace of rate cuts. If December's cut continues, it would represent a decline of a full percentage point since September.

“To strike a balance between the need to maintain a modestly restrictive stance on monetary policy and the possibility that policy will not be far from neutral, I think we are at or near the point where it makes sense to slow the pace of interest rate cuts,” Hammack said. , this year's voting member of the Federal Open Market Committee.

The only thing left on the docket that could keep the Fed from cutting in December is the release next week of separate consumer and producer price reports. The consumer price index is expected to show an increase of 2.7%. Fed officials will enter their quiet period after Friday, when they will not give policy speeches before the meeting.

The issue of 'neutral' interest rates, which neither restrict nor stimulate growth, is central to how the Fed will conduct its policy. Recent indications suggest that the level could be higher than in previous economic climates.

What the Fed could do is implement the December rate cut, skip January as traders expect, and perhaps make another cut in early 2025 before taking a break, said Tom Porcelli, chief U.S. economist at PFIM Fixed Income.

“I don't think there's anything in today's numbers that would stop them from making cuts in December,” Porcelli said. “When they raised rates as much as they did, it was for a very different inflation regime than we have now. So in that context, I think Powell would like to continue the process of normalizing policy.”

Powell and his fellow policymakers say they are now paying as much attention to controlling inflation as supporting the labor market, whereas previously the focus was much more on prices.

“If you want until you see cracks from a labor market perspective and then start adjusting policy, it's too late,” he said. “So prudence would really suggest that you start that process now.”