The Fed is mired in "civil war," and a rate cut in December has become a "coin toss" gamble.

Written by: White55, Mars Finance

A fierce policy divergence battle is currently playing out within the Federal Reserve, one of the most intense in recent years. According to the latest statistics, among the 12 FOMC members with voting rights this year, 5 have clearly expressed a preference to remain on hold in December, while another faction, including the influential New York Fed President Williams, supports continuing to cut interest rates.

Since the Federal Reserve's most recent interest rate decision on October 29, Chairman Powell has unexpectedly remained silent, while his colleagues have taken to the media and public forums to articulate their respective positions, laying bare the internal conflicts before the public.

Polymarket data shows that the probability of interest rate cuts has risen to over 67%.

The depth of this divergence can be seen from the drastic fluctuations in market expectations: within just a few weeks, the probability of a rate cut in December plummeted from a high of 95% to below 30%, and then quickly rebounded to above 60% after Williams' speech. Behind this roller coaster of expectation changes lies an irreconcilable conflict in policy ideas within the Federal Reserve.

The Silent Powell and the Divided Committee

Powell's unusual silence strategy has sparked widespread speculation. Claudia Sam, an economist who formerly worked at the Federal Reserve, interprets this as “Powell's choice to remain silent at this moment allows every member of the FOMC to express their opinions and be heard,” suggesting that this hands-off approach to internal debate is “actually a good thing” in the current complex environment. Against the backdrop of Powell's silence, divisions within the Federal Reserve are becoming increasingly public.

The results of the October monetary policy meeting have shown signs of polarization — at that time, the Federal Reserve announced a 25 basis point rate cut with a vote of 10-2. Surprisingly, the camp that originally supported the rate cut is now fracturing. St. Louis Fed President Bullard, who supported the rate cut last month, has now shifted to a skeptical position, stating “We must proceed with caution at this moment, which is critical.”

What is more noteworthy is that Chicago Fed President Goolsbee, along with these former dovish officials, has also hinted at a possible shift towards a more cautious stance. During his nearly three years at the Federal Reserve, Goolsbee has never voted against, but he now explicitly states: “If I ultimately firmly support a certain position that is contrary to everyone else's views, then so be it. I think that is healthy.”

Hawks vs Doves - Ideological Clash Under Data Deficiency

The Federal Reserve is currently divided into three major factions.

On one side are the hawks, represented by Kansas City Fed President George, who emphasize that inflation risks can no longer be ignored. George warned, “In my view, given that inflation remains at elevated levels, monetary policy should restrain demand growth to create space for supply expansion.”

On the other hand, there is the dovish faction led by Federal Reserve Governor Milan, who not only supports a rate cut but even calls for a 50 basis point reduction at the December meeting. Milan believes: “There is already ample evidence that inflation is declining rapidly and the labor market is weak, so further easing of policy is imperative.”

The centrist camp is represented by Daly, the president of the San Francisco Federal Reserve, who is open to interest rate cuts but emphasizes caution. Daly pointed out: “We also do not want to make the mistake of keeping the policy rate too long, only to find that it ultimately harms the economy. Formulating the right policies requires maintaining an open mind.”

This divergence was foreshadowed in the July meeting, when for the first time in 32 years, two board members, Waller and Bowman, cast dissenting votes against the chair, breaking the long-standing consensus culture of the Federal Reserve.

Data Black Hole and the Federal Reserve Dilemma of Government Shutdown

One major difficulty in the Federal Reserve's decision-making dilemma this time lies in the lack of key economic data. The federal government shutdown has caused the release of official data to come to a standstill, and the Bureau of Labor Statistics has clearly stated that it will not release the employment report for October, while the CPI data for November will also be delayed until December 18—everything will occur after the Federal Reserve's interest rate meeting in December.

Powell himself has likened this predicament to “driving in a fog,” where “you would slow down.” The lack of data forces the Federal Reserve to rely on private sector data, and the economic picture painted by this information is filled with contradictions.

On one hand, inflation remains persistently high. The consumer price index in September rose by 3% year-on-year, significantly above the Federal Reserve's inflation target of 2%. Particularly concerning is the resilience of service inflation—core service prices, such as housing and healthcare, have maintained a year-on-year increase of over 3.5%.

On the other hand, the job market shows signs of cooling. According to data from employment consulting firm Challenger, U.S. companies announced layoffs of 153,000 in October, a surge of 183% compared to September, marking the highest level for the same period in over 20 years. The Chicago Federal Reserve's estimate report indicates that the U.S. unemployment rate may slightly rise to 4.4%, the highest level in four years.

Market voting model and the probability of a 50-50 interest rate cut

In the face of such obvious divisions within the Federal Reserve, market participants had to change their strategy from focusing on the Fed consensus to “counting votes one by one.” This shift in strategy clearly reflects the failure of the Fed's communication mechanism and has led to significant fluctuations in market expectations.

Morgan Stanley analysts pointed out that the missing data and the delayed release of employment market indicators mean that “the Federal Reserve will face a dilemma of incomplete information when making decisions at its December meeting.” This uncertainty has led traders to reflect a high level of uncertainty in their bets on the December decision. New York Fed President Williams' remarks last Friday briefly changed the market landscape. As the third-ranking official in the Federal Reserve, Williams stated that “a rate cut in the near future may be reasonable,” which significantly raised investors' expectations for a rate cut in December.

However, the hawkish remarks made by Boston Fed President Collins last Saturday dampened the market's enthusiasm. Collins stated that “there is no need for the Fed to continue cutting rates in December,” emphasizing that “there are risks regarding inflation, and a moderately restrictive policy helps ensure that inflation declines.”

Currently, the CME FedWatch Tool shows that the probability of the Federal Reserve lowering interest rates by 25 basis points in December is 71%, while the probability of maintaining rates is 29%. However, many analysts believe the actual situation is more complex. Deutsche Bank senior economist Brett Ryan and others think that Williams' statement has locked in a rate cut, while former Fed economist Claudia Sahm candidly stated, “I really think it's still a 50-50 chance.”

Historical Reflection and the Defense of the Federal Reserve's Independence

Current internal divisions are not unprecedented in the history of the Federal Reserve. In the 1980s, when the Federal Reserve pushed interest rates to punitive highs to curb high inflation, and in the 1990s, when ongoing concerns about price pressures led many policymakers to worry about excessive accommodation, there were numerous dissenting votes.

However, the peculiarity of this divergence lies in the unprecedented political pressure backdrop. President Trump has repeatedly expressed his dissatisfaction with Powell, even “half-jokingly threatening” at the US-Saudi Business Forum that “if interest rates don't go down, I'll fire Treasury Secretary Mnuchin.” This political pressure, intertwined with internal disputes, has raised deep concerns about the Federal Reserve's independence. Economists warn that the tense relationship between the White House and the Fed may undermine the central bank's independence in monetary policy and impair its ability to control inflation. Dallas Fed President Logan pointed out the fundamental dilemma in current decision-making: “Uncertainty is a universal characteristic of macroeconomic and monetary policy formulation. Policymakers cannot precisely understand the current state of every relevant aspect of the economy, yet they must still make policy decisions.”

The probability numbers from the Fed's observation tool are still fluctuating, but more analysts are beginning to align with Claudia Sam's assessment—that the debate is genuinely a 50-50 situation. Regardless of the outcome of the December 10 meeting, Powell will face a divided committee, and his leadership will be put to an unprecedented test.

The market has realized that the era when the Federal Reserve could easily reach a consensus is over. As Federal Reserve Governor Waller said, “You may see the FOMC exhibit the least amount of groupthink it has in a long time.”