Fed set to cut rates amid election uncertainty and cooling inflation

As the US prepares for Tuesday's presidential election, the Federal Reserve is poised to make a more predictable decision on interest rates just two days later. With inflation showing signs of easing, the Fed is expected to cut interest rates for the second time this year according to a detailed report by Associated Press.

Despite potential uncertainty surrounding the election results, analysts believe this will not impact the Fed's decision-making process during its upcoming two-day meeting, concluding on November 7, the Associated Press report elaborated further.

The Fed, led by Chair Jerome Powell, is anticipated to reduce its benchmark rate by a quarter-point to approximately 4.6 per cent. This follows a half-point cut in September. Economists predict another rate cut in December, with further reductions likely next year, aimed at lowering borrowing costs for consumers and businesses.

Fed’s approach reflects a shift towards a lower inflation environment

Traditionally, the Fed lowers rates to stimulate a sluggish economy and boost a weak job market. However, the current economic landscape is different: growth is robust, with an unemployment rate of just 4.1 per cent. Despite recent disruptions from natural disasters and strikes affecting job growth, the Fed’s approach reflects a shift toward a "lower-inflation environment" rather than a direct response to economic weakness.

The Fed's aggressive rate hikes over the past year, prompted by soaring inflation that peaked at 9.1 per cent in June 2022, are now giving way to a more cautious stance. Year-over-year inflation has dropped to 2.4 per cent, nearing the Fed's target of 2 per cent. This significant decline suggests that high borrowing rates are no longer necessary and that previous restrictions on lending might be excessive.

Claudia Sahm, chief economist at New Century Advisors, emphasises that the rationale for maintaining elevated rates has dissipated as inflation concerns have subsided. Most Fed officials are advocating for gradual rate reductions, with discussions centered around finding the "neutral" rate that neither stimulates nor restrains economic growth. The Fed's rate-setting committee estimates this neutral rate at about 2.9 per cent, while many economists suggest it may be closer to 3 per cent to 3.5 per cent.

The future course of Fed policy could become more complex once a new president and Congress take office in January. If Donald Trump reclaims the presidency, his proposed economic policies, which include imposing high tariffs on imports and threatening the independence of the Fed, could potentially push inflation in the US economy to higher levels.

Economists have warned that such measures might force the Fed to reconsider its current path of rate cuts, as higher inflation could necessitate a halt or reversal of these reductions.

Powell is likely to address questions about the election's impact on the economy during the upcoming meeting, reiterating the Fed's commitment to apolitical decision-making. Economists remain concerned about Trump’s broader tariff proposals, predicting they could increase inflation significantly, with one report estimating an additional 2 percentage points of inflation next year if implemented.

Hence, as the Fed prepares to cut rates amid cooling inflation, the political landscape may soon introduce variables that complicate future monetary policy. The most powerful central bank in the world will need to navigate these changes carefully to maintain its goals for economic stability and growth.