Could the Fed Skip a Rate Cut in November?

The US presidential election won’t be the markets’ only test next week. On Thursday, the Federal Reserve will conclude its first policy-setting meeting since September, when it made a jumbo interest rate cut. Amid a slew of strong economic data to come out since then, some market watchers are discussing whether the Fed could dramatically slow the pace of cuts, including by skipping a cut altogether next week.

That doesn’t look likely. Bond futures markets overwhelmingly expect the Fed to proceed with a 0.25% rate cut, according to the CME FedWatch Tool. But a November cut doesn’t preclude a pause further down the line. Here’s what investors need to know.

Fed Likely to Cut Rates in November

In the weeks since the Fed’s first cut, market expectations for its next move have changed dramatically. Investors saw more than a one-in-three chance of another big 0.5% cut happening in November as recently as a month ago, but CME FedWatch data shows that the odds of that outcome have now plummeted to zero. The chances of the Fed keeping rates steady have also shrunk to nearly zero.

Strong economic data—like 2.8% GDP growth in the third quarter and inflation’s continued moderation in September—indicates Fed policy has successfully brought down price pressures without damaging growth so far. That’s giving investors more confidence that rates will continue to fall.

Unknown in this equation is the labor market, which has been cooling from very hot levels since the covid-19 pandemic. A series of weaker data prints at the end of the summer helped set the stage for the Fed’s first big interest-rate cut.

“The Fed looked at that picture, saw the evolving risk, saw some building downside risk for a labor market that is less able to generate inflation pressure, and started to take its foot off the brake,” explains Roger Hallam, global head of rates at Vanguard.

Why Cut Rates Again Now?

Analysts say very restrictive interest rates mean the Fed will be looking to ease pressure to avoid damaging the jobs market further, even if that process happens a little at a time. With runaway inflation no longer an immediate threat, the central bank can continue to cut rates.

“I don’t think there’s any view that they were anywhere close to a neutral level of Fed funds, and that’s why they should continue to go,” says Greg Wilensky, head of US fixed income at Janus Henderson Investors. A neutral rate is an interest rate that’s neither stimulative nor restrictive. It can’t be measured directly, but it’s estimated to be around 2.5%. The federal-funds rate target range is currently 4.75%-5.00%.

Despite distortions from two hurricanes and a major labor strike, Friday’s tepid nonfarm payrolls report helped solidify the case for a November cut. That report had “enough uncertainty that the Fed will certainly feel comfortable following through with its plans of an additional cut,” Hallam says. He’s anticipating another rate cut to follow in December.

“Fed Chair Powell has stated that he does not want to see further weakening in the labor market, so this week’s data should ensure that the Fed will cut rates by 25 basis points,” Brian Rose, senior US economist at UBS Global Wealth Management, wrote in a note to clients on Friday.

That’s not to mention the risk to equities markets if the Fed surprises investors, says Mark Hackett, chief of investment research at Nationwide. “The Fed really doesn’t want to spook the market,” he says.

A Strong Economy Could Mean a Pause in Rate Cuts Down the Line

Less clear is the path of interest rates in 2025. “Mathematically, we cannot be cutting rates every single time in the future,” says Wilensky. With cuts totaling roughly 1.25% priced in by the bond market before the end of 2025 and 10 meetings over that period, there are bound to be a few skips.

Analysts say strong economic data next year could prompt such pauses. Assuming the pace of disinflation remains relatively steady, Morningstar chief US economist Preston Caldwell says “a skip becomes more likely” after December, “unless the data shows a more substantial reduction in inflation and/or measures of economic growth.”

Fed officials have also expressed this view. “I’m not in a rush to get to neutral,” Atlanta Fed President Raphael Bostic said at an event hosted by the Mississippi Council on Economic Education last month. “I don’t want us to get to a place where inflation stalls out because we haven’t been restrictive long enough, so I’m going to be patient.”

Hallam emphasizes that the trajectory of rates next year will depend on how the economic data shakes out. “If we think the current pace of growth is unsustainably strong, the Fed will likely continue to ease next year,” he says. “But if the current pace of growth continues at 3%-ish, the Fed will have to change its plans.”

Wilensky says the Fed’s Summary of Economic Projections, released periodically throughout the year and containing Fed official’s projections for rates and other economic indicators, will offer clues about whether a skip could be in the cards. The next SEP will be released at the central bank’s December meeting. Public comments from Fed officials may also provide clues.

The Bottom Line for Investors

Wilensky says investors can take confidence that falling inflation means the Fed has some wiggle room, and that may include a pause in rate cuts. It’s a different world than two years ago, when inflation was at a four-decade high and the central bank kept rates high to tame it, even if the economy weakened dramatically. “When inflation was running too hot, the Fed had to pivot focus on bringing inflation lower, and it had to do that at the expense of growth,” Hallam explains.

“The key takeaway is that with inflation moving back toward target, it gives the Federal Reserve a lot of flexibility going forward,” adds Wilensky. If we continue to pace towards a soft landing, the Fed will lower rates slowly over time. But if the economy weakens quickly, the Fed will have room to respond by lowering rates more aggressively, he explains. That can help mitigate the downside to the economy and financial markets.

Hallam says investors shouldn’t lose sleep over the Fed pausing cuts because the economy looks strong: “From an overall portfolio context, your equities and your credit exposure will be doing fine.”