Glide path no more?

Bottom Line

The Federal Reserve cut interest rates by a quarter point at last Thursday’s policy-setting meeting, which had been widely expected, bringing the upper band of the fed funds rate down to 4.75%. But last year’s decline in inflation has seemingly stalled, economic growth has rebounded, and October’s disastrous labor-market report—largely due to a pair of extreme hurricanes and two since-settled strikes—may be revised away in coming months. Moreover, last week’s stunning Trump Trifecta could introduce stimulative fiscal policies resulting in stronger economic growth.

Consequently, there is now some uncertainty regarding the pace of the Fed’s ongoing rate-cutting plans. In its most recent Summary of Economic Projections, released at its September 18 FOMC meeting, the Fed expected quarter-point cuts at its November and December meetings, followed by four quarterly cuts in 2025 and perhaps two more in 2026. Collectively, that would take the fed funds rate down to a terminal value of about 3%. That path now seems overly optimistic.

Our current thinking is that a more gradual data-dependent path to a terminal value of perhaps 3.75% or so over the course of the next year seems more plausible. Benchmark 10-year Treasury yields have surged from 3.6% to nearly 4.5% over the past two months, although yields have receded back to 4.30% in recent days. However, we can’t rule out a longer-term retest of overhead resistance at perhaps 4.75% or 5.00%, given the prospects for higher inflation.

Sticky and persistent While the Fed has made steady progress lowering inflation over the past two years, we have seen a reacceleration in several key metrics recently:

• Average hourly earnings ticked up by a hotter-than-expected 0.4% m/m in October (which annualizes to 4.8%) and by 4.0% year-over-year (y/y). The Fed is targeting 3%. But last month’s noisy jobs report may have created a mix shift of employees who couldn’t get to work due to the bad weather. 
• Unit labor costs rose by a much stronger-than-expected 1.9% quarter-on-quarter annualized rate in the third quarter (consensus at 1.0%), and the second quarter was revised sharply higher, surging to an increase of 2.4% from a modest preliminary gain of 0.4%. The Labor Department revised historical data for five years with this report.
• Core PPI wholesale inflation has risen from 1.8% y/y in December 2023 to 2.8% in September 2024, and October is expected to rise further to 3.0%. 
• Core CPI retail inflation has declined from 3.9% y/y in December 2023, but it has stalled at 3.2-3.3% over each of the past four months through September 2024, a trend that is expected to continue in October at 3.3%. 
• Core PCE inflation (the Fed’s preferred measure) declined from 5.6% in February 2022 but has stalled at 2.7% y/y in four of the past five months through September 2024. The Fed is targeting 2%.

GDP rebounds From a disappointing growth rate of 1.6% in this year’s first quarter, GDP has reaccelerated to 3.0% and 2.8%, respectively, in this year’s second and third quarters, fueled by rebounds in personal consumption. We’re expecting 2.0% growth in the current fourth quarter, while the Atlanta Fed’s GDPNow forecast is at 2.5%. So, it appears as if the Fed has successfully stuck the soft landing.

Noisy labor market The October ADP private payroll survey was twice as strong as expected (gain of 233,000 jobs, consensus at 111,000), and initial weekly jobless claims hit a five-month low at 218,000 for the week ended October 26. But nonfarm payrolls rose by a much weaker-than-expected 12,000 jobs in October, with a combined downward revision of 112,000 jobs in August and September. This is the slowest pace of job growth since December 2020, and the adjusted October payroll represents a disastrous loss of 100,000 jobs.

But 45,000 dock workers affecting all East Coast and gulf ports staged a short walk-out in October, and 33,000 Boeing machinists recently ended their strike. The labor market was also distorted last month by two powerful hurricanes (Helene and Milton) in the Southeast.

According to the Bureau of Labor Statistics, the response rate for their October survey of businesses last month was only 47.4% (the lowest level since 1991) due to the twin storms, compared with a normal 90% response rate. In addition, 512,000 people in nonagricultural jobs could not work due to the inclement weather, compared with the historical average for October of 56,000. So, the deadly storms prevented 456,000 more people than normal from working last month. 

Collectively, that suggests that October’s dismal labor-market performance could be revised up sharply in coming months, when companies report their actual hiring to the Labor Department again. We could also see a sizable snap-back to normal hiring trends.

Red Wave The Trump Trifecta could pass fiscal policy legislation resulting in stronger economic growth and possibly higher inflation in coming years. Such policies could include deregulation, lower corporate tax rates, a permanent extension of the personal tax cuts originally passed in 2017, and increased energy production, among other plans.

At last week’s FOMC meeting, Fed Chair Jerome Powell said that it was too soon to say how President Trump’s fiscal policies—if they eventually pass through Congress into law—might spur stronger economic growth. “In the near term, the election will have no effects on our policy decisions,” he said. True enough. But central banks both here and abroad will be watching intently at the first half of Trump’s lame-duck term to glean any clues to adjust monetary policy accordingly.

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