Volkswacht Bodensee - US Fed set to make first rate cut since 2020

Senior officials at the US central bank including Fed chair Jerome Powell have in recent weeks indicated that a rate cut is coming this month, as inflation eases toward the bank's long-term target of two percent, and the labor market continues to cool.

The decision will affect the rates at which commercial banks lend to consumers and businesses, affecting the cost of borrowing on everything from mortgages to credit cards.

Traders and analysts remain uncertain about how sharply the Fed will lower its benchmark lending rate from the current 23-year high of between 5.25 and 5.50 percent.

Some are banking on a smaller cut of a quarter of a percentage point, and others are backing a bigger half-point reduction.

A smaller cut would be a more predictable move, while a bigger move would do more to boost demand -- while also running the risk of reigniting inflation.

"It's around points of inflection that we get the most mixed signals," Erica Groshen, a senior economics advisor at the Cornell University School of Industrial and Labor Relations, told AFP.

"The Fed is trying to make sense out of them. And the markets are trying to make sense out of them, and trying to make sense out of how the Fed will interpret them," added Groshen, a former vice president at the New York Fed.

- Lower borrowing costs -

Futures traders saw a 63 percent chance on Tuesday that the Fed would announce a bigger, half percentage-point move on Wednesday, and a 37 percent chance it would go with a more conventional 25 basis point cut, according to CME Group data.

When the Fed cuts interest rates, commercial banks in the United States generally follow, reducing borrowing costs and stimulating demand in the world's largest economy.

For the Fed, a rate cut of any size would signal that consumer inflation, which hit a four-decade high in 2022, was returning to target.

While there is a "compelling risk management case to support a larger move," recent Fed communications and data did not "argue clearly" for a larger cut, economists at Deutsche Bank wrote in a recent investor note, predicting a 25 basis point cut.

"We remain of the view that the Fed will opt for a 25bps (basis point) rate cut to start its easing cycle," EY chief economist Gregory Daco wrote in a note to clients.

- US election stakes -

Analysts overwhelmingly expect the Fed to announce it is cutting rates on Wednesday, though there is less clarity about what comes next.

In June, rate-setting committee members sharply reduced the number of cuts they had penciled in for this year from a median of three down to just one, amid a small uptick in inflation.

But as inflation has fallen in the months since, and the labor market has cooled, analysts at top US banks have raised the number of cuts they expect the Fed to pencil in this year.

The Fed has a dual mandate from Congress to act independently to set monetary policy to ensure both stable prices and maximum sustainable employment.

But if it announces a cut on Wednesday, the Biden-Harris White House is likely to claim it as proof that their economic agenda is working and that the long-running battle against inflation is being won.

That could raise the spirits of US consumers, who have consistently named the cost of living and inflation as top concerns ahead of November's election in which former Republican president Donald Trump is running against Democratic Vice President Kamala Harris.

S.Spengler--VB