The U.S. government shutdown is pushing the Federal Reserve into an exceptionally difficult situation. If key employment and inflation data remain unavailable before the December policy meeting, policymakers may be forced to make critical interest rate decisions in an information "vacuum," significantly increasing the likelihood of them "blindly cutting rates" based on an established dovish path.

According to a report released by Bank of America on October 28, the scenario of the Federal Reserve being "in the dark" during the December meeting is becoming increasingly realistic. The report points out that not only is there no progress on ending the government shutdown, but even if the government reopens, it may take months for data flows to return to normal.

This lack of data exacerbates existing divisions within the FOMC. A dovish camp, possibly including Chair Powell, may insist on the rate-cutting path hinted at in the September dot plot. However, hawkish members of the committee are likely to oppose a third rate cut this year in the absence of new evidence of economic weakness.

For investors, this unprecedented uncertainty significantly raises the risks surrounding the December meeting. The final policy decision may no longer depend on the latest economic indicators but rather rely more on a divided committee weighing old expectations against new risks, which could lead to a situation where both hawks and doves cast opposing votes, introducing greater variability into market expectations.

Data Shortages May Intensify Internal Divisions

Bank of America's analysis suggests that the September FOMC meeting revealed profound divisions among policymakers regarding the assessment of downside risks in the labor market. At that time, a slim majority believed these risks were sufficient to support at least a 75 basis point rate cut this year.

In the absence of new data, this dovish group is likely to push for fulfilling the expectations set in the September dot plot. The report states that some dovish members may even argue that the prolonged government shutdown itself amplifies the downside risks to economic activity, thus providing another reason to support a rate cut.

However, the hawkish forces within the committee cannot be ignored. The September dot plot indicated that seven FOMC participants supported only one rate cut this year. Bank of America believes this camp includes four voting members: Barr, Goolsbee, Musalem, and Schmid. While they are not expected to raise objections to a rate cut at this week's meeting, pushing for a third cut in December may be "too much" for them, especially given the stability in unemployment claims reported at the state level. This increases the risk of at least one hawkish dissenting vote at the December meeting, and dovish member Miran may also cast a dissenting vote.

Timing of Data Recovery Determines Policy Path

The Federal Reserve's final decision in December will heavily depend on when the government shutdown ends and to what extent economic data can catch up. Bank of America has outlined several scenarios.

Scenario 1: An "outdated" September employment report is obtained before the end of November. If the government reopens before the end of November, the market should see the September employment report before the December meeting. The report suggests that weak data would reduce the risk of a hawkish dissenting vote, but even strong data is unlikely to convince Powell to pause rate cuts, as the report would be viewed as "outdated."

Scenario 2: Employment reports for September and October are obtained in early November. If the shutdown ends in early November, allowing the Bureau of Labor Statistics (BLS) to release two reports before the December meeting, the situation becomes more complex. In this case, if the unemployment rate remains stable at 4.3% and the economic activity data from September to October is robust enough, a "pause in rate cuts" in December could become a viable option.

Scenario 3: Data fully catches up, with three employment reports obtained. The ideal situation would be for the government to quickly end the shutdown, allowing the BLS to conduct surveys for both October and November, thus releasing all three employment reports for September, October, and November before the December meeting. In this case, Bank of America proposes a decision-making rule of thumb: if the November unemployment rate is at or below 4.3%, the Federal Reserve will likely maintain rates in December; if the unemployment rate is at or above 4.5% (consistent with the Fed's economic projections in the SEP), it will prompt a rate cut. If the unemployment rate falls in the middle ground of 4.4%, the December decision will be a "close call" and will depend on a broader flow of data, including inflation.

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