The Fed’s Next Interest Rate Move Is Anyone’s Guess—That’s Unusual

When Federal Reserve officials meet Wednesday, they might do something they usually try to avoid—make a surprise decision. 

While Fed officials have signaled their intentions to cut the central bank’s key interest rate at this week’s pivotal meeting, financial market participants aren’t sure whether the cut will be 50 or 25 basis points. As of Monday afternoon, markets were pricing in a 67% chance of the larger cut, according to the CME Group’s FedWatch tool, which forecasts interest rate movements based on fed funds futures trading data. That was up from about 50% on Friday and 30% a week ago.

The odds being that close to a coin flip are unusual so close to the Fed meeting. Central bankers don’t make statements to the public about monetary policy during the 10-day “blackout period” leading up to every Federal Open Market Committee meeting. However, investors, economists, and experts can usually predict the Fed’s next interest rate move will be based on news and economic data. 

Predictability is Key For the Fed

The fact that the Fed’s moves are usually telegraphed in advance is no accident—the Fed and other central banks around the world generally try to avoid last-minute surprises to financial markets, believing monetary policy is more effective when it’s predictable. 

However, recent economic data has been mixed, and rate cut expectations have swung up and down several times in the days leading up to the meeting.

Sophia Kearney-Lederman, senior economist at FHN Financial, said she expects markets to stabilize in favor of one or the other at some point before the meeting, likely on the side of a smaller cut. 

“I expect you’ll see the market settle closer to where they really think and lean in one direction,” she said. “This sort of oscillation has really largely just been a reflection of the data that we’ve seen in the past month and a half.” 

However, if the odds stay in the middle, either those betting on larger or smaller cuts will have their expectations upended. In an analysis Monday morning, economists at Deutsche Bank said that it could be the biggest rate cut “surprise” in more than 15 years.

The Fed’s Balancing Act

The unsettled predictions are a reflection of the difficult decision Fed policymakers face. 

The Fed is preparing to begin reversing the campaign of interest rate hikes it started in March 2022 to subdue a spike in inflation. Between March 2022 and July 2023, the Fed raised its benchmark interest rate from near zero to a range of 5.25% to 5.5%, the highest level since 2001. 

The hikes were an effort to push up borrowing costs on mortgages, credit cards, car loans and other debt in an effort to discourage borrowing and spending—and in turn, cool down an economy central bankers saw as overheating.

Since then, the inflation rate has fallen from its highest level in more than 40 years and is now nearing the Fed’s annual goal of 2%. At the same time, the Fed’s high interest rates have slowed the economy nearly to the point where the unemployment rate could rise too high for comfort. The Fed’s mission, set by Congress, is to keep interest rates low enough to prevent mass layoffs but high enough to keep a lid on inflation.

Several key reports on the state of inflation and the labor market have sent mixed signals about whether inflation or unemployment poses the greatest threat to the economy’s health. That’s given ammunition to people who argue for the Fed to take a cautious approach and cut rates slowly, as well as to those who contend that fast and furious rate cuts are needed.

What Lies Ahead

In the end, the most consequential decision Fed officials make this week may not be whether to go for a 50- or 25-basis-point cut but the message they send their future plans. 

The Fed’s policy announcement on Wednesday is set to include quarterly economic and interest rate projections by FOMC members. Kearney-Lederman said she would be keeping a close eye on those to better understand how fast interest rates could fall in the coming months.

“The magnitude and the timing of future rate cuts is really what we’re all starting to question now because we know the time is now to ease,” she said. “That, I think, is going to be a much bigger focus for the meeting.”

According to the CME’s FedWatch tool, the market is pricing in about a 65% chance that the Fed will slice at least 125 basis points from the benchmark rate by the end of the year. That means the market expects the Fed will carry out 50-basis-point cuts at two of the remaining three policy meetings in 2024.