The Fed has a big interest rate decision coming Wednesday. Here’s what to expect

Inflation is stubbornly above target, the economy is growing at about a 3% pace and the labor market is holding strong. Put it all together and it sounds like a perfect recipe for the Federal Reserve to raise interest rates or at least to stay put.

That’s not what is likely to happen, however, when the Federal Open Market Committee, the central bank’s rate-setting entity, announces its policy decision Wednesday.

Instead, futures market traders are pricing in a near-certainty that the FOMC actually will lower its benchmark overnight borrowing rate by a quarter percentage point, or 25 basis points. That would take it down to a target range of 4.25%-4.5%.

Even with the high level of market anticipation, it could be a decision that comes under an unusual level of scrutiny. A CNBC survey found that while 93% of respondents said they expect a cut, only 63% said it is the right thing to do.

“I’d be inclined to say ‘no cut,'” former Kansas City Fed President Esther George said Tuesday during a CNBC “Squawk Box” interview. “Let’s wait and see how the data comes in. Twenty-five basis points usually doesn’t make or break where we are, but I do think it is a time to signal to markets and to the public that they have not taken their eye off the ball of inflation.”

Inflation indeed remains a nettlesome problem for policymakers.

While the annual rate has come down substantially from its 40-year peak in mid-2022, it has been mired around the 2.5%-3% range for much of 2024. The Fed targets inflation at 2%.

The Commerce Department is expected to report Friday that the personal consumption expenditures price index, the Fed’s preferred inflation gauge, ticked higher in November to 2.5%, or 2.9% on the core reading that excludes food and energy.

Justifying a rate cut in that environment will require some deft communication from Chair Jerome Powell and the committee. Former Boston Fed President Eric Rosengren also recently told CNBC that he would not cut at this meeting.

“They’re very clear about what their target is, and as we’re watching inflation data come in, we’re seeing that it’s not continuing to decelerate in the same manner that it had earlier,” George said. “So that, I think, is a reason to be cautious and to really think about how much of this easing of policy is required to keep the economy on track.”

Fed officials who have spoken in favor of cutting say that policy doesn’t need to be as restrictive in the current environment and they don’t want to risk damaging the labor market.

If the Fed follows through on the cut, it will mark a full percentage point lopped off the federal funds rate since September.

While that’s a considerable amount of easing in a short period of time, Fed officials have tools at their disposal to let the markets know that future cuts won’t come so easily.

One of those tools is the dot-plot matrix of individual members’ expectations for rates over the next few years. That will be updated Wednesday along with the rest of the Summary of Economic Projections that will include informal outlooks for inflation, unemployment and gross domestic product.

Another is the use of guidance in the post-meeting statement to indicate where the committee sees policy headed. Finally, Powell can use his news conference to provide further clues.

It’s the Powell parley with the media that markets will be watching most closely, followed by the dot plot. Powell recently said the Fed “can afford to be a little more cautious” about how quickly it eases amid what he characterized as a “strong” economy.

“We’ll see them leaning into the direction of travel, to begin the process of moving up their inflation forecast,” said Vincent Reinhardt, BNY Mellon chief economist and former director of the Division of Monetary Affairs at the Fed, where he served 24 years. “The dots [will] drift up a little bit, and [there will be] a big preoccupation at the press conference with the idea of skipping meetings. So it’ll turn out to be a hawkish cut in that regard.”

Thus far, the chair and his colleagues have brushed aside questions about the impact Trump’s initiatives could have on monetary policy, citing uncertainty over what is just talk now and what will become reality later. Some economists think the incoming president’s plans for aggressive tariffs, tax cuts and mass deportations could aggravate inflation even more.