The Economy Does Not Need More Rate Cuts
The latest economic data suggests that the Federal Reserve should halt any further rate cuts. Growth remains resilient, inflation is sticky, and the labor market shows unexpected vigor, all pointing to the need for a more cautious approach.
The economy expanded at a solid 2.8 percent annual rate in the third quarter of 2024, based on the Commerce Department’s initial GDP estimate. Growth could have been even stronger if not for the lingering impact of a potential port workers’ strike, which likely inflated import numbers temporarily. Trade and inventory fluctuations shaved 0.8 percent off the headline growth figure and could reverse in the coming months, adding further strength to economic momentum.
Consumer spending, a key driver of GDP, continues to surprise on the upside. Expenditures increased at a 3.7 percent annual pace—the fastest since early 2023. Goods spending surged by six percent, while durable goods spending jumped eight percent, reflecting broad-based consumer confidence. Meanwhile, final sales to domestic private purchasers rose 3.2 percent, indicating solid underlying demand within the private sector.
Business investment also points to confidence, with nonresidential fixed investment rising at a respectable 3.3 percent annual rate. Particularly notable was the 11.1 percent spike in equipment investment, signaling companies’ willingness to bet on future productivity.
Labor market indicators further affirm the economy’s strength. Despite a decline in job openings in September, hiring has picked up, with durable goods manufacturing employment rebounding from 171,000 to 209,000 and retail jobs rising from 571,000 to 609,000. Weekly jobless claims also undershot expectations, settling at 216,000—a signal that layoffs remain low.
The Fed Trapped Itself
Given these signs of resilience, the Fed’s claim that rates are restrictive is now highly doubtful. What exactly is being restricted? Economic activity seems anything but constrained.
Inflation dynamics also argue against further cuts. While the headline PCE price index ticked close to the Fed’s two percent target, core inflation is still sticky. The core PCE price index rose by 0.3 percent in September, the sharpest increase since April, putting the annual rate at 3.1 percent. The Cleveland Fed’s median PCE stands at 3.2 percent, largely unchanged for half a year. This suggests we may be settling into a three percent inflation environment, distinct from the Fed’s two percent goal.
The Fed, unfortunately, finds itself boxed into a corner. After making an aggressive cut in September, halting further cuts could look like an admission of error. And, if Donald Trump wins the election next week, avoiding a cut might even appear politically motivated. So, the Fed now has to cut in November—and maybe even again in December—even though the economic data calls for a pause.
It’s very likely, however, that after this year, the Fed will take a slower pace. Instead of the successive cuts the market had been expecting, it is likely that the Fed will decide to take several months at the start of the year to assess economic conditions before it makes another cut. Ultimately, the Fed’s so-called “terminal rate” is likely to be higher than the Fed currently estimates.