Set for November 7, the Federal Reserve’s next policy announcement comes hot on the heels of the U.S. election. There’s every chance that another trimming of the interest rate is on the horizon, with either a 0.25% or 0.5% decrease under consideration. Market data will play an integral role in the FOMC’s discussions, shaping the pivotal decision about America’s fiscal future.
In the context of this important decision, the result of the presidential election is unlikely to sway the Fed. It is intended to operate independently of the political landscape, making choices based on economic conditions and outlook, not on the pass-and-play change of politicians. However, it will not operate blindly. Should the election result still be a question mark on the day of their announcement, it could potentially influence the Fed’s decisions regarding the rate cut.
A considerable bigger cut might be on the cards if the election outcome is cloaked in ambiguity, as financial uncertainty tends to amplify the fragility of markets. The Federal Open Market Committee is all too aware of this ticking time bomb. Should the U.S. presidential race still be unresolved into November 7, the committee may feel obliged to mitigate the possible fallout.
Let’s be clear on this: the largest short-term economic risk for the United States is the possibility of an unresolved Presidential Election. The uncertainty of leadership can create a vacuum, sucking down the performance of equity markets and investments across the board. Not knowing who your next president might be is akin to stepping into economic quicksand.
Such confusion can have a domino effect, stalling business investments and curtailing consumer spending. The specter of political violence amidst the prevailing uncertainty only serves to compound these effects. Should the President-elect remain unnamed by the appointed date, the Fed has to factor in these looming threats into its decision-making process.
Recall the year 2000 when such a situation unfolded causing the economy to tumble into recession. A murky election result then triggered a significant contraction in GDP during the first quarter of 2001. In the unfortunate event of a similar scenario this year – extended recounts, potential lawsuits, an unclear victor – the Fed might be compelled to slice the rates by 0.5%; hoping to counter negative business emotions and dwindling confidence borne out of such uncertainty.
Currently, there isn’t a consensus on the potential size of the impending cut scheduled for November 7. A real-time snapshot from the CME FedWatch tool proved revealing on September 25, 1:01 p.m. ET: A 60% chance of a 0.5% cut meets a 40% chance of a 0.25% cut. Just weeks before, the landscape was markedly different. The possibility of a 0.5% cut then was a slim 14% on September 11.
Ahead, we are likely to see a downward trend in interest rates, continuing at least till the end of 2026 if we trust the Federal Open Market Committee members’ projections from September 18. This is a much-needed silver lining for interest rate-sensitive industries like construction and manufacturing. A drop in interest rates is like injecting these industries with a growth hormone, stimulating hiring and injecting optimism into the labor market.
As the dollar deflates under lower interest rates, exporting businesses sigh with relief. A weaker dollar acts as a catalyst for boosting exports, strengthening the economy’s global stance. An environment of reduced interest rates also bodes well for equity markets, bond prices, oil prices, and industrial metals, fostering upside risks.
Companies see their weighted average cost of capital tapering as interest rates descend. This is great news for businesses both in the public and private sectors. It means that their business valuations are likely to swell, painting an attractive picture for potential investors. Overall, these dynamics are beneficial, creating an environment conducive to economic growth.
But, a big cloud hangs overhead in the form of the U.S. Presidential Election. Uncertainty related to the election results has the potential to overshadow the financial markets and introduce unprecedented risk. It’s a pitfall that monetary policy makers are keen to sidestep.
Thus, the Fed might consider slashing deeper to keep the downside risks in check. More so, if clarity about the President-elect remains elusive by November 7. One analogy would be a surgeon amputating a limb to prevent gangrene from spreading through the body. The Federal Reserve might similarly feel the need to make a larger cut than otherwise planned – a proactive measure to safeguard the country’s economic health.
Rest assured, the Federal Reserve will base its important decisions on current market conditions, possible economic consequences, and the lessons learned from past. Their primary goal remains the stability and continuous growth of America’s economy – which they will strive to maintain, no matter the political storm that may be raging.