Federal Reserve and Interest Rate Cuts

Investing.com — The Federal Reserve may face increased challenges in labeling further aggressive interest rate cuts as “normalization” if unemployment remains higher than expected, according to analysts at Citi.

In a note to clients, the analysts noted that under such circumstances, the Fed may be “pushed” to halt its ongoing balance sheet reduction despite high reserves.

Following a substantial 50-basis point interest rate cut last month, Fed Chair Jerome Powell stated that the central bank is not considering stopping balance sheet reductions, pointing to “still abundant” reserves, which are anticipated to remain plentiful for some time.

Therefore, Powell emphasized that continuing quantitative tightening—reducing the liquidity added through bond purchases during the COVID-19 pandemic—is essential.

Currently, quantitative tightening has reduced the Fed’s holdings from $9 trillion in 2022 to about $7.1 trillion.

Citi analysts predict that if the unemployment rate stabilizes at or below 4.4% and job growth continues, the Fed will maintain its balance sheet runoff until the end of Q2 2025.

Investors will soon review a new jobs report on Friday, which may clarify future Fed policies. Several officials have cited a need to support the labor market amid declining inflation as a key reason for last month’s significant rate cut.

Economists project that the U.S. economy will add 144,000 jobs in September, a slight increase from 142,000 in August. The unemployment rate is expected to match August’s 4.2% level.

In August, payrolls increased from a significantly downwardly revised figure of 89,000, falling short of forecasts of 164,000, with the unemployment rate decreasing from 4.3%.