On Wednesday, the US Federal Reserve is expected to announce its first interest rate cut since 2020. How big that will be remains to be seen, but it is widely expected to aim for a quarter-percentage point cut from the current level of 5.3%.
The economy continues to send mixed signals. The unemployment rate remains at a historic low of 4.2% – but it has risen slightly in four of the last five months, a trend that often precedes recessions. While layoffs remain low, hiring has virtually ground to a halt, particularly in some white-collar jobs, making job hunting unusually difficult for many.
A retail sales report released on Tuesday showed a stable spending pace overall in the US, although some spending categories such as restaurant spending were significantly weaker.
Although a cut is almost certain based on the signals the central bank has been giving in recent weeks, it is still unclear whether the Fed will cut by a quarter or half a percentage point. Some say half a percentage point is necessary to avoid a recession, while others say it would be a sign of a negative surprise, suggesting economic weaknesses that the market has so far overlooked.
In a note to clients ahead of Wednesday’s Fed statement, Bank of America economists said that while there is a case for a 0.5% hike given weakening data, the “baseline” scenario – the most likely – assumes a “soft landing” of the economy with relatively low unemployment and relatively low inflation, but concerns about further deterioration remain.
“The main message from the meeting should be cautious optimism despite the downside risks,” they wrote.
Others said the Fed’s timetable for further rate cuts was ultimately more relevant than the cut announced on Wednesday. The central bank has historically preferred to move gradually – usually in 0.25 percent increments – unless it is faced with an emergency. But a majority of market participants currently believe that, given the current economic situation, the Fed will need to cut rates by at least 1.5 percent at its next four meetings.
This would mean a reduction of at least half a percentage point by the time the Fed announces its key interest rate in January.
Jay Bryson, chief economist at Wells Fargo, currently puts the odds of a recession at 1 in 3, based on rising delinquencies and a savings rate that suggests consumers are spending more than they would like to keep up with inflation.
“We’re seeing some cracks in the economy,” he told NBC News.
The Fed is convinced that the interest rate cut planned for Wednesday and the interest rate cuts likely to follow in the coming months will pave the way for a further deterioration in the economy.
However, it is unclear how quickly consumers and businesses can or will benefit from lower interest rates if they sense that overall demand in the economy is declining.
Some economic observers believe that there are no signs of this.
“Layoffs remain low and job openings plentiful, GDP is growing at a healthy pace and there have been no major adverse shocks,” said David Mericle, Goldman Sachs’ chief U.S. economist, in a note to clients.
But not everyone shares this view.
Economists at financial group Citi believe an even more significant downturn is on the way. They point to surveys that show the largest share of small businesses expect profits to fall since 2010 and that hiring is expected to remain low. They also point out that home purchases and construction have not increased despite the recent cut in mortgage rates, which they say is due to weaker demand.
“Companies have been reducing their hiring rate to reduce labor costs,” the Citi economists wrote. “If the overall hiring rate falls, workers will be less inclined to leave their current jobs and companies will be forced to actively cut staff.”
