Economists Expect Soft Landing as Fed Prepares for Key Decision on Rate Cuts

Key Insights:

• Inflation eases to 2.5%, but core inflation remains a concern due to rising shelter costs.
• Economists expect a soft landing, with U.S. economic growth continuing without a recession in 2024.
• Fed faces a tough choice between a 25 or 50 basis point rate cut amid cooling inflation.

The Federal Reserve is preparing for an important policy meeting this week amid cooling inflation and growing uncertainty over its next move on interest rates. With inflation slowing and the labor market showing signs of weakness, the central bank is widely expected to cut rates, but there is no consensus on whether it will be by 25 or 50 basis points.

Recent data show inflation is coming down, with the consumer price index (CPI) rising 2.5% over the last 12 months—the lowest annual increase since February 2021. The inflation rate is moving closer to the Fed’s 2% target, but uncertainties surrounding the labor market and broader economic conditions make the Fed’s decision less straightforward.

Inflation Eases, But Core Inflation Remains a Concern

Recent inflation data suggest that price pressures are easing after the sharp increases seen in 2021 and 2022. The all-items CPI increased by just 0.2% in August, bringing the annual inflation rate to 2.5%. This figure is a relief for policymakers after the prolonged period of high inflation. However, core inflation, which excludes volatile food and energy prices, remains at 3.2%.

A significant portion of the persistent core inflation is driven by rising shelter costs. The Bureau of Labor Statistics reported that “owners’ equivalent rent” increased by 5.4% over the past year, contributing substantially to the overall inflation rate. Despite this, consumer confidence is improving, with a University of Michigan survey showing inflation expectations for the next year at 2.7%, the lowest since December 2020.

Although inflation has cooled, there are concerns that the fight against rising prices is not over. Federal Reserve Chair Jerome Powell has expressed optimism about inflation returning to 2%, but he has also noted that the Fed does not want to see further cooling in the labor market.

Divided Opinions on Rate Cut Size

There is an ongoing debate among economists and market participants over how much the Fed should cut interest rates. Many expect a reduction, but opinions differ on the size of the cut. Futures markets initially leaned toward a 25 basis point reduction, but by the end of last week, they showed nearly equal odds between a 25 and 50 basis point cut.

Claudia Sahm, chief economist at New Century Advisors, believes that a 50 basis point cut would be more appropriate given the recent inflation data. “The federal funds rate has been over 5% for more than a year to combat inflation. That fight is won. They need to start getting out of the way,” she stated, emphasizing that a larger cut could help prevent further deterioration in the labor market.

Others, such as Tom Simons, an economist at Jefferies, advocate for a smaller 25 basis point cut. “They are normalizing policy, not trying to provide accommodation for an economy in trouble,” Simons said. He argued that the Fed should maintain a cautious approach to ensure inflation remains under control and avoid moving too quickly with rate cuts.

Economists Expect Soft Landing for the U.S. Economy

Despite the ongoing debate about rate cuts, many economists predict that the U.S. economy will avoid a recession and achieve a “soft landing” as inflation continues to fall. A recent survey conducted by the Financial Times and the University of Chicago’s Booth School of Business found that economists expect the U.S. economy to grow by 2.3% in 2024 and 2% in 2025.

The same survey indicated that most economists do not foresee a significant economic contraction in the near future. Dean Croushore, a former economist at the Federal Reserve Bank of Philadelphia, commented that “things are still pretty strong across the board,” reflecting widespread optimism about the economy’s ability to navigate the current challenges.

Political Uncertainty Looms Over Fed’s Decision

The Federal Reserve’s upcoming rate decision also comes at a politically sensitive time, with just weeks remaining before the U.S. presidential election. Economic policies differ sharply between the candidates, with Donald Trump advocating for tariffs and corporate tax breaks, while Vice President Kamala Harris focuses on tackling price-gouging and increasing taxes on the wealthy.

According to a survey, 70% of economists believe that Trump’s platform would be more inflationary than Harris’s. Additionally, many economists expect larger budget deficits under Trump’s policies compared to Harris’s proposals. While politics should not influence the Fed’s decision-making process, the election outcome may shape future economic policies, which could, in turn, affect inflation and interest rate trends.