The Federal Reserve today announced a 50 basis point (or half-percentage point) cut in the Fed Funds Rate. Heading into this afternoon’s decision, bond investors were divided as to whether the Fed would move cautiously and gradually with a 25 basis point cut, or present a more assertive signal. The Fed went with assertive.
The Fed Funds Rate has now been brought down to a range of 4.75% to 5% from the prior range of 5.25% to 5.5%.
Members of the Federal Reserve Board, along with all the Federal Reserve Bank presidents, also shared their expectations of where they think the Fed Funds Rate will be at the end of 2024, 2025 and 2026. The median forecasts were 4.4%, 3.4% and 2.9%, all of which were significantly below their prior forecasts. In July, the median forecasts were 5.1%, 4.1% and 3.1%.
Markets not terribly spooked, but should they be?
The last FOMC Meeting was less than two months ago on July 31, 2024. At that point, the Fed chose to keep rates unchanged and offered a much different perspective on where rates were heading over the next three years.
Over the past 25 years, the Fed has only gone with half-point rate cuts in very difficult economic circumstances. In 2001, the Fed engaged in multiple half-point cuts as the dotcom bubble burst and then later after the September 11th attacks. In 2008, the Fed cut rates aggressively amidst the financial crisis. In 2020, we saw 50 basis point cuts as Covid brought the economy to a standstill.
Stocks initially rallied after the larger cut was announced at 2pm today, with the S&P 500 up more than 0.5%, but then drifted over the course of the trading day. The S&P 500 in fact closed down 0.3%.
Either half a point was largely priced in… or some investors were indeed uneasy with the implications of such a sharp move.
What is the state of the economy?
Since the last meeting in July, there have been a number of developments that suggest the jobs picture in the United States is in fact much less robust than it has been perceived. New jobs data have disappointed expectations, while severe revisions were applied to previous payroll numbers over the past year.
During the post-announcement press conference, Fed Chair Powell was keen to paint a picture consistent with a soft landing scenario. In practical terms, this suggests the Fed is on a path to bring inflation back to its long-run 2% target without triggering a recession.
On the labor front, Powell acknowledged that the labor market, while cooling, is coming off “overheated” levels. He insisted labor is no longer a source of inflationary pressure. Powell told reporters the labor market was in “solid condition” and that the intention was “to keep it there.”
On the inflation front, the message was that inflation rates were drifting towards targeted levels. When asked if it was time to declare victory on inflation, Powell explained that he was “not saying mission accomplished,” but that he is “encouraged.” This is what now allows the Fed to move away from a policy that has been “highly restrictive.”
Pressed by another reporter as to whether or not the 50 basis point cut demonstrated a concern that there were significant risks on the horizon, Powell denied that they were seeing anything in the economy that indicated “elevated risks of a downturn.”
Where do we go from here?
The economy is coming off, as Powell just described it, a “burst of inflation” that necessitated lifting interest rates well above neutral levels, which are widely seen as being in the 2.5% to 3% range.
While inflation has been decelerating, as Powell acknowledged, it remains above target. As rate cuts get implemented to support the labor market, we will have to see what kind of impact that has on prices going forward.
The interplay between interest rates and housing is an interesting example of the uncertainty ahead. The subject came up during the press conference.
There is a view that part of the upward pressure we have witnessed in housing prices relates to the fact that many homeowners are essentially frozen in place because they don’t want to give up in-place mortgages with low interest rates. But the traditional relationship between interest rates and house prices is that the lower mortgage rates go, the more buyers can pay, which drives up prices.
Powell essentially disavowed responsibility for rising house prices, pointing instead to a chronic shortage of homes. He rather clearly stated this is a problem that needs to be solved by the markets and the government, rather than the Fed. He essentially acknowledged today’s rate cuts may only exacerbate a critical pain point for many Americans dealing with the inflation crisis of the last several years.
Powell seems to be tentatively patting himself on the back for engineering a soft landing, but he quite clearly misread the not so “transitory” inflation that had been taking root as early as mid-2001.
The Consumer Price Index rose 7% at year-end 2021, yet the Fed Funds Rate did not come off the zero bound until March of 2022, when the Fed finally hiked 25 basis points. Today’s 50 basis point move perhaps reflects some regret about being too hesitant to act in the other direction two years ago.
