The Fed has evidence that inflation is decreasing, but its next action remains uncertain.

• Since 2021-22, the substantial decrease in price pressures was evident from a week's worth of inflation data.
• Officials from the government are approaching their objective of low inflation as they gather for a two-day conference on policy on Tuesday, but the extent to which they will reduce interest rates is still uncertain.
• Economist Claudia Sahm stated that the federal funds rate, which has been above 5% for over a year, was successful in fighting inflation. However, she advised that it is now time for the rate to decrease.

As they approach their objective of low inflation, Federal Reserve officials are more confident, but the extent to which they will reduce interest rates is still uncertain.

Since their rapid increase in 2021-22, inflation pressures have significantly decreased, as indicated by a gauge of consumer prices showing 12-month inflation at its lowest since February 2021. Additionally, wholesale price measures suggest that pipeline price increases are mostly under control.

The two readings were sufficient to pave the way for a Federal Open Market Committee meeting rate cut, which will take place on Wednesday and include a forecast on the direction central bankers anticipate for the future.

"Claudia Sahm, chief economist for New Century Advisors, stated in a CNBC interview on Friday that the Fed received two more months of good inflation data since their last meeting."

The central bank's direction is unclear as financial markets failed to provide a clear indication.

The CME Group's FedWatch tool showed that traders had an almost even chance of a 25- or a 50-basis point rate cut in futures markets on Friday, after a quarter percentage point rate cut had been the focus for most of the past week.

Sahm is among those who think the Fed should go bigger.

The federal funds rate has been over 5% for over a year to fight inflation. That fight is won. They need to start getting out of the way.

Sahm proposed a 50 basis-point reduction to establish a safety net against potential labor market decline.

"Since last July, the labor market has weakened, and there is a need to recalibrate. Fed officials need to clean up the information, cut 50 basis points, and be prepared to do more."

Confidence about inflation

Although the fight to reduce inflation to 2% is not yet over, the latest reports suggest that progress is being made in the right direction.

In August, the all-items consumer price index increased by 0.2%, resulting in a full-year inflation rate of 2.5%. However, excluding food and energy, the core inflation rate was 3.2%, which is significantly higher than the Fed's target.

The Bureau of Labor Statistics' "owners equivalent rent" measure, which accounts for about 27% of the total CPI weighting, has contributed significantly to the core strength of the housing market, with a 5.4% increase from the previous year.

Although there are still some pressures, consumer surveys suggest that inflation has been reduced, if not completely eliminated. According to a University of Michigan survey in September, respondents expect inflation to be 2.7% over the next 12 months, which is the lowest reading since December 2020.

In late August, Fed Chair Jerome Powell stated that his confidence has increased that inflation will return to 2%.

Powell stated in his speech at the Fed's annual retreat in Jackson Hole, Wyoming, that the Fed does not desire or welcome a further decrease in labor market conditions.

The primary mission of the Fed, which is to maintain stable prices and a healthy job market, appears set to change.

"Sahm stated that if Powell wants to fulfill his promise of no further weakening or cooling, he must take drastic action by moving here, as the cooling trend is already established. The unemployment rate will continue to rise until the trend is interrupted."

The case for a quarter

The Fed is likely to lower interest rates by a quarter-point at its next meeting, indicating that it still has work to do on inflation and is not overly concerned about the labor market or a broader economic slowdown.

"According to Tom Simons, U.S. economist at Jefferies, the key is for policymakers to focus on normalizing policy rather than accommodating an economy that is struggling. Simons believes that policymakers have effectively communicated this perspective so far."

If Simons' quarter-point move forecast is correct, the Fed will still have ample space to act further.

By the end of 2024, market pricing suggests that benchmark borrowing costs could decrease by 1.25 percentage points, indicating a sense of urgency to lower rates from their current high of 5.25% to 5.50% in more than 23 years.

"The reason for their caution in cutting is due to their concern about inflation returning, but now, with data suggesting inflation isn't coming back, they have more confidence. However, they must monitor any potential changes in dynamics carefully."