The Federal Reserve will make a significant interest rate decision on Wednesday.

• The Fed is expected to decrease its benchmark borrowing rate by a quarter percentage point on Wednesday, according to futures market traders.
• During a CNBC "Squawk Box" interview on Tuesday, former Kansas City Fed President Esther George stated, "I'd say 'no cut.'"
• The Fed will also update its "dot plot" and collective outlook on the economy in addition to the rate decision.

The Federal Reserve should raise interest rates or remain unchanged due to inflation being above target, a 3% economic growth pace, and a strong labor market.

On Wednesday, when the Federal Open Market Committee announces its policy decision, it is unlikely that the central bank's rate-setting entity will make a decision that is not what is expected.

The FOMC is expected to lower its benchmark overnight borrowing rate by 25 basis points, bringing it within a target range of 4.25%-4.5%.

Despite the high level of market anticipation, the decision to cut may face an unusual level of scrutiny. A CNBC survey revealed that while 93% of respondents expect a cut, only 63% said it is the right thing to do.

"Esther George, former President of the Kansas City Fed, stated during a CNBC "Squawk Box" interview on Tuesday that she would likely say "no cut" and advised waiting for more data before making a decision. She emphasized that while 25 basis points may not significantly impact their current position, it is important to signal to markets and the public that they are closely monitoring inflation."

Inflation indeed remains a nettlesome problem for policymakers.

The annual rate has decreased significantly from its 40-year high in mid-2022, but has remained around 2.5%-3% for most of 2024. The Fed aims for inflation of 2%.

The Fed's preferred inflation gauge, the personal consumption expenditures price index, increased to 2.5% or 2.9% on the core reading that excludes food and energy in November.

To justify a rate cut in the current environment, Chair Jerome Powell and the committee will need to communicate effectively. Additionally, former Boston Fed President Eric Rosengren stated on CNBC that he would not cut rates at this meeting.

"George stated that they are clear about their target and as inflation data is coming in, it is not decelerating at the same rate as before. Therefore, he believes it is necessary to be cautious and consider the amount of easing of policy needed to keep the economy on track."

Officials who support reducing restrictions argue that the current climate calls for less stringent policies and that they do not want to harm the job market.

Chance of a 'hawkish cut'

If the Fed cuts the federal funds rate, it will result in a full percentage point reduction since September.

Fed officials have the ability to communicate to the markets that future rate cuts will not be as easy to come by.

The dot-plot matrix of individual members' expectations for rates over the next few years will be updated on Wednesday, along with the Summary of Economic Projections, which will include informal outlooks for inflation, unemployment, and gross domestic product.

Another way to express the same idea is: "The committee's post-meeting statement can provide guidance on where policy is headed, and Powell can use his news conference to provide additional clues."

The Powell parley with the media will be closely watched, followed by the dot plot. Powell recently stated that the Fed can afford to be more cautious about easing quickly in a "strong" economy.

"According to Vincent Reinhardt, BNY Mellon chief economist and former director of the Division of Monetary Affairs at the Fed, who served 24 years, we will observe them leaning into the direction of travel to begin the process of moving up their inflation forecast. 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. As a result, it will turn out to be a hawkish cut in that regard."

What about Trump?

It is likely that Powell will be questioned about how fiscal policy might align with President-elect Trump's policies.

The chair and his colleagues have dismissed questions about the impact of Trump's initiatives on monetary policy, stating uncertainty over what is currently speculation and what will become reality in the future. Some economists believe that the incoming president's plans for aggressive tariffs, tax cuts, and mass deportations could exacerbate inflation even further.

"Reinhart stated that the Fed is facing a dilemma, which they used to refer to as the "trapeze artist problem." As a trapeze artist, one cannot swing out from their platform until they are certain their partner has swung out. Similarly, the central bank cannot adjust their forecast based on their political economy beliefs until they are confident that the changes will occur."

"At the press conference, a major concern is the possibility of missing meetings. I believe this will result in a cautious approach, which may be adjusted as Trump's policies are implemented and their impact is felt."

Other actions on tap

In 2025, most Wall Street forecasters predict that the Fed will increase its inflation expectations and decrease its rate cut expectations.

Officials indicated in September that they planned to make four quarter-point cuts next year. However, markets have lowered their expectations for easing, predicting only two cuts in 2025 after this week's move, according to the CME Group's FedWatch measure.

The Fed is predicted to omit the January meeting, and Wall Street anticipates no significant alterations in the post-meeting statement.

Officials may increase their estimate for the "neutral" rate of interest, which neither stimulates nor slows down growth. This rate has been around 2.5% for years, consisting of a 2% inflation rate plus 0.5% at the "natural" level of interest. However, it has risen in recent months and may surpass 3% during this week's update.

The committee may adjust the interest it pays on its overnight repo operations by 0.05 percentage point in response to the fed funds rate drifting to near the bottom of its target range. The "ON RPP" rate acts as a floor for the funds rate and is currently at 4.55% while the effective funds rate is 4.58%. Minutes from the November FOMC meeting indicated officials were considering a "technical adjustment" to the rate.