US Federal Reserve prepares for first interest rate cut in over four years ahead of 2024 presidential election

The U.S. Federal Reserve (Fed) is expected to announce its first interest rate cut in over four years since 2020 this week, months before the U.S. presidential election scheduled for November 2024, AFP reported.

It added that Fed policymakers will discuss how large the interest rate cut will be this week ahead of the expected announcement on September 18 (US local time).

Leading Fed officials, including Chairman Jerome Powell, have indicated that a rate cut is imminent as inflation in the US approaches the central bank's target of two percent and the labor market continues to cool, the report said.

“Interest rate cut based solely on economic data”

The US Congress has required the central bank to act independently to ensure stable prices and sustainable employment, and the Fed has often stressed that its decision to cut interest rates will be based “solely on economic data,” the AFP report said.

A cut this week would still be a “headache” for Powell, as it comes just two months before the election campaign between Kamala Harris (Democratic candidate and US Vice President) and Donald Trump (Republican candidate and former US President).

“Even though I think the Fed tries to claim it's not a political entity, we're in a really wild cycle right now,” Alicia Modestino, associate professor of economics at Northeastern University and former chief economist at the Federal Reserve Bank of Boston, told AFP.

How big the cuts are to be expected?

On September 17 and 18, policymakers will debate whether the cut should be 25 or 50 basis points.

Both numbers would be significant, however, as this would be the Fed's first rate cut since March 2020, when it cut rates to near zero to support the U.S. economy during the Covid-19 pandemic.

The Fed began raising interest rates in 2022 in response to a rise in inflation fueled largely by a post-pandemic supply crunch and the war in Ukraine. For the past 14 months, it has kept its benchmark interest rate at a two-decade high of between 5.25 and 5.50 percent, waiting for economic conditions to improve.

With inflation falling, the labor market cooling and continued U.S. economic growth, policymakers have now concluded that conditions are ripe for a rate cut.

Take things slowly or be more aggressive

Policymakers face a choice: either make a small cut of 25 basis points to ease things, or cut rates more drastically by 50 basis points to support the labor market despite the risk of a resurgence in inflation.

“I think there is not enough data ahead of the November meeting to say that we are at risk on the employment side,” Modestino said.

Analysts believe the smaller cut is a sure thing. “We expect the Fed to cut interest rates by 25 basis points,” economists at Bank of America recently wrote in a note to their clients.

“The Fed likes predictability. That's good for markets, good for consumers, good for workers. A 25 basis point cut now, followed by another 25 basis point cut in November after the next round of economic data, provides a slightly smoother glide path for the economy,” Modestino added.

How many cuts can be expected?

While analysts overwhelmingly expect the Federal Reserve to begin cutting interest rates in September, what will come after that is less clear. Many hope the central bank will lay out its course in the updated economic forecast to be released on September 18.

The forecast will come from the Fed's 19-member interest rate committee and will include their expectations for a rate cut, the report said.

In June, FOMC members reduced the number of cuts planned for this year from an average of three to just one, amid a slight increase in inflation. But with inflation falling and the labor market weakening, expectations for more cuts have risen.

“We continue to expect three rate cuts of 25 basis points each at the remaining FOMC meetings in 2024,” Jan Hatzius, chief economist at Goldman Sachs, wrote in a note to clients last week.

Traders also believe that there is a greater than 99 percent chance of at least four more rate cuts in 2025. The Fed's key interest rate would then fall to 3.5 to 3.75 percent – 175 basis points below current levels.