Core Viewpoint - The Federal Reserve is expected to cut its benchmark interest rate by a quarter-point in October due to concerns about the deteriorating job market outweighing inflation fears [2][9]. Group 1: Interest Rate Cut Expectations - The Federal Open Market Committee is likely to reduce the fed funds rate to a range of 3.75% to 4%, marking its second cut in consecutive meetings [3]. - Financial markets are pricing in a near certainty of a quarter-point rate cut in October and another cut in December [4][9]. - The Fed's decision-making is complicated by its dual mandate to maintain low inflation and high employment [4]. Group 2: Economic Implications - A rate cut will bring the fed funds rate closer to a "neutral" level, which neither stimulates nor hinders economic activity [5]. - The Fed's focus has shifted from high inflation to the health of the job market, as job creation has significantly slowed [6][9]. - By cutting the fed funds rate, the central bank aims to lower borrowing costs to encourage borrowing and boost hiring [6][9]. Group 3: External Factors - Tariffs are contributing to both price increases and job market slowdowns, creating uncertainty for business leaders and discouraging expansion [7]. - Recent data showed that the Consumer Price Index rose less than expected in September, solidifying expectations for the rate cut [8]. - The ongoing government shutdown is delaying important economic reports, which may affect the Fed's future decisions [10].

Economic Overview - The Federal Reserve (Fed) faces a dual mandate to maintain low inflation and high employment, using the fed funds rate as a tool to influence economic conditions [1] - Currently, both inflation and the job market are deteriorating simultaneously, creating a dilemma for the Fed regarding which issue to prioritize [1] Interest Rate Expectations - Investors anticipate a reduction in the fed funds rate by 0.25 percentage points to a range of 3.75% to 4%, marking the lowest level since December 2022 [3] - A rate cut is expected to lower interest costs on short-term debts such as credit cards and car loans, while also reducing returns on CDs and high-yield savings accounts [2] Employment Situation - Recent reports indicate a slowdown in the job market, with job losses recorded in June and only 22,000 jobs added in August [4] - An increase in unemployment insurance claims suggests more individuals are remaining unemployed for longer periods [4] Inflation Trends - The Fed's preferred inflation measure, core Personal Consumption Expenditures, rose by 2.9% over the past year, aligning with forecasts and supporting the case for a rate cut [5] - Inflation has been accelerating, moving further away from the Fed's target of a 2% annual rate, with tariffs cited as a significant factor in rising consumer prices [6] Government Shutdown Risks - A potential partial government shutdown starting October 1 could delay the release of critical economic data, including the jobs report due on October 3 [7] Federal Reserve Governance - The upcoming Fed meeting may be influenced by political pressures, particularly regarding the status of Fed governor Lisa Cook, who has faced attempts at removal by President Trump [8][9] - The Federal Open Market Committee (FOMC) is responsible for setting the fed funds rate and consists of 12 voting members [10][11]

Core Points - The Federal Open Market Committee (FOMC) is evaluating whether the federal funds rate remains the appropriate operating target for short-term interest rates, given the evolution of the financial system and money markets [1][2][3] Group 1: Historical Context and Evolution - The FOMC has historically adapted its operating targets to maintain influence over monetary conditions as the financial system has evolved, indicating a need for potential updates to the current target [3][4] - The transition to targeting the fed funds rate in the mid-1990s was a response to changes in the economy and financial system, making it a useful indicator of monetary conditions [12][19] - The Fed's operating targets have shifted over time, reflecting different economic goals, such as controlling inflation and stabilizing the macroeconomy post-World War II [10][11] Group 2: Changes in Money Markets - Since the mid-1990s, the money markets have undergone significant changes, with collateralized financing becoming more prevalent than uncollateralized interbank loans, diminishing the relevance of the fed funds market [4][21] - The volume of transactions in the fed funds market has decreased, with daily volumes now around $100 billion compared to over $4.5 trillion in repo markets, indicating a shift in market dynamics [28][29] - Regulatory changes post-Global Financial Crisis have further reduced the attractiveness of unsecured interbank lending, leading to a preference for secured funding [22][23] Group 3: Fragility of the Fed Funds Market - The connections between the fed funds market and broader money markets have become fragile, raising concerns about the effectiveness of the fed funds rate as an operating target [5][31] - The concentration of major lenders in the fed funds market, primarily the Federal Home Loan Banks (FHLBs), creates vulnerabilities that could impact monetary policy implementation [34][35] - A lack of trading volume in the fed funds market could lead to disconnection from other money markets, undermining its usefulness as a gauge for broader monetary conditions [36] Group 4: Alternative Operating Targets - The essay discusses potential alternative operating targets, including repo reference rates, which may provide more robust measures of monetary conditions than the fed funds rate [6][38] - Targeting a Treasury repo rate, such as the tri-party general collateral rate (TGCR), is proposed as a viable option due to its strong connections to broader money markets [52][60] - The Secured Overnight Financing Rate (SOFR) is also considered, but it may not provide as clean a gauge of liquidity costs as TGCR due to its combination of different market segments [57][58] Group 5: Benefits and Costs of Transitioning - Proactively transitioning to a different operating target could mitigate risks associated with the fragility of the fed funds market, although it would incur transition costs [68][69] - The effectiveness of policy transmission and the need for a well-developed understanding of the new target would be critical for successful implementation [70]