Fed Chair Powell’s allies provide opening for December rate cut

The unusual level of division inside the Fed means that, to an even greater degree than usual, the final call rests with Powell.

To negotiate these stark divisions, Powell is likely to weigh two approaches, each with drawbacks. The first: cut rates, as markets now expect, and use the exquisitely negotiated postmeeting statement to signal a higher bar for further reductions. This “cut then hold" approach would mirror what Powell did in late 2019 when, like now, three cuts met meaningful resistance from his colleagues.

This option would also likely trigger objections from officials who don’t support any cut. But it could end the soap opera of officials airing their disagreements in public by stitching together a new consensus that further cuts aren’t warranted if recent conditions persist.

The alternative is to hold rates steady and reassess in January, when officials will have more of the employment and inflation data that was suspended by a federal government shutdown. But that approach could prolong the public discord for another seven weeks, with no guarantee the additional data will resolve the underlying disagreements.

The divide reflects economic crosscurrents that have split the committee more than at any point in Powell’s nearly eight-year tenure: Job growth is stagnating but inflation is uncomfortably elevated, which carries a whiff of what economists call stagflation.

Because the labor market is cooling but not collapsing and inflation is neither accelerating nor improving meaningfully, “it’s hard to declare victory" on either side, Richmond Fed President Tom Barkin said in an interview last week.

Powell’s decision depends on what he considers the greater risk, and which would be harder to fix if he is wrong.

Two consecutive cuts brought rates down to a range between 3.75% and 4% last month to guard against the risks of softening job-market conditions, even as inflation has run closer to 3% than the Fed’s 2% goal.

A third cut in December would be consistent with the plan Powell laid out in August: move rates closer to neutral, a level that neither stimulates nor restrains activity, because tariff-related inflation risks had lessened while labor-market weakness had become a greater concern.

Two of Powell’s top allies on the rate-setting committee have offered hints that Fed leadership hasn’t given up on that strategy.

On Friday, New York Fed President John Williams said he still saw “room for a further adjustment in the near term…to move the stance of policy closer to the range of neutral." Williams’s carefully chosen words—especially “near term"—suggested cutting is the path of least regret.

While it is “imperative" to return inflation to 2%, it is “equally important to do so without creating undue risks" to the labor market, Williams said. Market-implied probability of a December cut flipped to around 70% from 40% after he spoke.

San Francisco Fed President Mary Daly, a Powell ally who doesn’t vote on interest-rate decisions this year, said in an interview Monday that she supports cutting rates in December because she sees a sudden deterioration in the job market as both more likely and harder to manage than an inflation flare-up.

If tariff-driven cost increases accelerate or spread into service prices, “we’d see it and be able to get ahead of it. It’s not going to be a spike, like we saw in the pandemic," Daly said. “On the labor market, I don’t feel as confident we can get ahead of it. It’s vulnerable enough now" that if layoffs start to rise a little, they could rise a lot more.

The comments by Williams and Daly are significant because they follow a period when officials who opposed a cut dominated the public debate.

Support for a December cut had been fragile from the start. After cutting rates in September, a narrow majority of 19 meeting participants thought reductions would be warranted in October and December. Of the 19, 12 can vote: all seven Washington-based governors, the New York Fed president, and four of the other 11 Fed presidents, who take turns voting. While a decision requires only a simple majority of 7-5, there hasn’t been a decision with more than three dissenting votes since 1992.

The breadth of resistance to a third cut became more apparent after the second cut in October. Four voting Fed presidents, including one that dissented last month, signaled concerns about cutting again.

They see price growth elevated not only for tariff-exposed goods, where pressures could intensify, but also for domestic services, suggesting inflation is broadening. They worry that the Fed is lowering rates too quickly toward neutral when they should remain restrictive to bring down inflation.

Boston Fed President Susan Collins exemplifies the shift. She voted for October’s rate cut but told reporters Saturday she is “hesitant" about further reductions because the current “mildly restrictive" rate setting may be needed to manage inflation.

Given relatively solid demand and financial conditions that are “a bit of a tailwind," she said, “it doesn’t suggest urgency to be more accommodative."

Robert Kaplan, who as Dallas Fed president between 2015 and 2021 served alongside Powell, thinks those opposing a cut have a point. The Fed’s options are asymmetric as rates approach neutral because it can cut if the economy is weaker than expected, he said, but if inflation is a bigger worry, rates could be too low to provide meaningful restraint.

But Kaplan, who is now at Goldman Sachs, also understood how an official who leans against a particular action could be persuaded to support it. During his own tenure, if there were times he was only slightly at odds with Powell, “if at all possible, I’m going to try to side with the chair, understanding that none of us are smart enough to know exactly the right decision."

Write to Nick Timiraos at Nick.Timiraos@wsj.com