The minutes of the Federal Reserve meeting are coming tonight, focusing on three major issues!

Faced with uncertainties such as the Republican Party's rise in power, increased productivity, and slow improvement in inflation, several Federal Reserve officials have indicated that they are willing to cut interest rates at a more cautious pace next year.

The minutes of the Federal Open Market Committee (FOMC) November 6-7 are scheduled to be released at 3 a.m. the next day, which may provide more clues as to whether policymakers are reconsidering the speed and extent of reducing borrowing costs.

Federal Reserve Chairman Powell, Governor Bowman, Dallas Federal Reserve Chairman Logan and others have suggested that they are not in a hurry to cut interest rates, but no one ruled out the possibility of cutting interest rates at the next meeting of the Federal Reserve in December.

Nationwide's chief economist Kathy Bostjancic said, “They want to ensure they have options because economic growth is more resilient and inflation shows more stickiness.”

Federal Reserve officials cut interest rates in November, but investors have cut their bets on cutting interest rates again next month. Market pricing shows that the probability that the Federal Reserve will cut interest rates by 25 basis points in December is only slightly above 50%, lower than about 80% before the November meeting.

The latest meeting minutes may shed light on the top three issues raised in recent public statements from policymakers:

Neutral interest rate or higher

Some Federal Reserve officials said that their goal now is to reduce policy interest rates over time to a level that neither suppresses nor stimulates the economy. But given the surprisingly strong economic performance of the past two years, many of them also seem to be re-evaluating what the so-called neutral interest rate is.

Bauman said on November 20, “My estimate of the neutral policy interest rate is much higher than before the pandemic.” If the Federal Reserve continues to cut interest rates, “the policy interest rate may reach or even fall below the neutral level until we achieve the price stability target.”

If borrowing costs fall below neutral, policymakers risk excessively stimulating the economy and inciting higher prices.

Logan said on November 13, “I have seen plenty of signs that the neutral interest rate has risen in recent years. Some signs suggest that the neutral interest rate may be very close to the current federal funds rate.”

Cutting interest rates by 25 basis points next month will reduce the federal funds rate to a range of 4.25% to 4.5%. Interest rate cuts of a full one percentage point since September last year have made the Federal Reserve the fastest rate cut since 2001, apart from the crisis. This would also make borrowing costs only about 75 basis points higher than investors' preferred neutral interest rate indicator.

Federal Reserve officials are required to submit their own estimates of the neutral interest rate (also known as the “long-term” federal funds rate) on a quarterly basis. These forecasts have been rising steadily, with a median forecast of 2.9% in September, up from 2.5% in December 2023. However, policymakers are seriously divided on the latest predictions: 12 officials expected a neutral interest rate range of 2.375% to 3%, while 7 officials expected 3.25% to 3.75%.

Both the economy and the market seem to agree that neutral interest rates are already higher. Although most Federal Reserve officials insist that the policy is restrictive, overall demand is actually healthy, and the inflation rate has not convincingly stabilized near the 2% target level.

Productivity soared

After years of tepid growth, the recovery in US labor productivity was another surprise.

As a key factor in improving living standards, the acceleration in hourly output has always been welcomed by Federal Reserve officials. This is a sign that the workforce has become more efficient with the help of more advanced technology. But it also poses problems with monetary policy.

A more efficient economy can achieve faster growth without triggering inflation. At the same time, maintaining this growth usually requires more capital investment.

Jason Thomas, head of global research and investment strategy at Carlyle Group Inc. (Carlyle Group Inc.), said that the increase in productivity, combined with tax cuts that may drive growth by the incoming Trump administration, has increased the risk that the Fed will cut interest rates too much or too fast.

He said, “As far as risk and reward are concerned, I can't imagine them willing to cut interest rates to this extent. When demand for capital and labor increases, if interest rates are too low, there will be excessive stimulation, which will generate inflation.”

Obviously, the Federal Reserve is trying to avoid this risk. Powell said on November 14, “The economy is not sending any signal that we need to hurry to cut interest rates.”

Thomas expects the Federal Reserve to cut interest rates once or twice, probably in March and June next year.

The outlook for inflation is uncertain

Federal Reserve officials believe they are achieving price stability, but they have not reached the point where they have reached the target, and President-elect Trump's proposal has brought great uncertainty. Deregulation and tax cuts may boost growth and spur inflation, while tariffs and the expulsion of illegal immigrants may curb consumption, investment, and growth, while also raising prices. No one really knows how these policy combinations will work.

Former Cleveland Federal Reserve Chairman Mester said that the conclusion drawn from the surge in inflation after the 2021 pandemic is that policies need to be prepared to deal with a series of risks in a period of high uncertainty, which may mean a gradual cut in interest rates.

“What you need to do is ensure that policies are in a good position so you can address risk in any way,” said Meester, who is now an adjunct professor of finance at the University of Pennsylvania's Wharton School (University of Pennsylvania's Wharton School). “With a strong economy, there's no reason to rush for results,” she said.