The Federal Reserve took a significant step on Wednesday by announcing an anticipated series of interest rate cuts. The U.S. central bank opted for a larger-than-usual reduction, cutting its benchmark policy rate by half a percentage point. This move signals the Fed’s commitment to maintaining economic stability, particularly in terms of unemployment, following the recent easing of inflationary pressures.

Federal Reserve Chair Jerome Powell explained during a press conference that this decision reflects policymakers’ increased confidence that inflation, which has plagued the U.S. economy for over two years, is finally under control. The new target range for the benchmark policy rate has been reduced to 4.75%–5.00%.

“We made a good strong start, and I am very pleased that we did,” Powell said, underscoring that the decision was driven both by economic logic and risk management. The choice to cut rates by 50 basis points instead of the expected 25 points was a bold move aimed at recalibrating the monetary landscape to reflect the sharp decline in inflation over the past year.

Powell’s leadership, characterized by a commitment to consensus-driven policymaking, faced a rare dissent in this decision. Michelle Bowman, a Fed governor, voted against the larger cut, preferring a smaller, quarter-percentage-point reduction. This dissent was the first of its kind since 2005, suggesting that some Fed members may have concerns about the pace and scale of the easing cycle.

Fed’s Strategic Shift: A Focus on Preemptive Action

The rate cut represents a significant shift in U.S. monetary policy. With inflation falling closer to the Fed’s 2% target, the central bank’s priority is now to avoid weakening the labor market. While the U.S. economy remains resilient, with unemployment rates at 4.2%, Powell emphasized that the decision was made to prevent any potential economic slowdown before it takes root.

Analysts have praised Powell’s ability to navigate the dual challenges of stabilizing inflation while preserving employment. Diane Swonk, the chief economist at KPMG, commented, “A soft landing is within reach, which would seal his legacy as Fed Chairman.”

This rate cut was accompanied by projections for additional cuts in the near future. Fed policymakers expect another half-percentage-point reduction by the end of 2024, a full percentage point cut in 2025, and another half-point drop in 2026. While these projections provide a roadmap for future policy decisions, the Fed cautioned that forecasting that far into the future remains speculative.

Why the Fed Cut Rates Now: Lessons from Inflation and Employment

For nearly two years, the Fed aggressively raised interest rates to combat inflation, which reached a 40-year high in 2022. After the prolonged hiking cycle, inflation has finally begun to stabilize, hovering just above the Fed’s 2% target.

Despite this progress, the Fed’s decision to lower rates reflects its desire to stay ahead of potential risks to the labor market. As Powell noted, “There is thinking that the time to support the labor market is when it is strong, and not when you begin to see layoffs.” By acting preemptively, the Fed aims to prevent job losses and sustain the positive momentum seen in the economy.

Additionally, the easing of monetary policy demonstrates the Fed’s willingness to support long-term economic growth without triggering excessive inflationary pressures. Historically, interest rate cuts can stimulate consumer spending and business investment, which in turn can drive further job creation.

Reactions from Political Figures

Given that the decision comes just weeks before the U.S. presidential election, it has naturally drawn political attention. Vice President Kamala Harris, who is running as the Democratic presidential candidate, welcomed the news, stating that the rate cut is “welcome news” for Americans struggling with high prices. “I know prices are still too high for many middle-class and working families,” Harris said in a statement.

In contrast, former President Donald Trump, the Republican nominee and the individual responsible for appointing Powell as Fed chair in 2018, expressed skepticism. He suggested that the size of the rate cut might indicate deeper economic problems. “To cut it by that much, assuming they’re not just playing politics, the economy would be very bad,” Trump remarked.

Powell, however, rejected such concerns, reiterating that the economy remains on strong footing. Despite recent signs of a slowdown in hiring and anecdotal reports of cautious corporate spending, the current 4.2% unemployment rate does not raise alarms. The Fed’s decision to act swiftly, according to Powell, is intended to prevent any weakening in the job market from spiraling out of control.

Market Reaction: Optimism Meets Uncertainty

The Fed’s decision elicited an immediate reaction from financial markets. U.S. stocks initially rose following the announcement but reversed course later in the day, closing lower. The U.S. dollar gained strength against a basket of major currencies, and yields on U.S. Treasury bonds increased as well.

Market participants appear to be factoring in the likelihood of further easing, with traders in interest rate futures now expecting the Fed to lower its policy rate to the 4.00%-4.25% range by the end of the year. This would mark an even more aggressive path than the one laid out by the Fed’s own projections.

Brian Jacobsen, chief economist at Annex Wealth Management, described the move as a “bang,” highlighting the Fed’s decision to cut rates by 50 basis points in one swoop. “It’s a strong signal that they cut by 50 basis points and expect another 50 basis points of cuts this year. This was controversial,” Jacobsen added.

Inflation and Economic Outlook

The Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index, currently sits about half a percentage point above the 2% target. New projections suggest that inflation will fall to 2.3% by the end of this year and dip to 2.1% by the close of 2025.

On the labor front, the unemployment rate is expected to settle at 4.4% by year-end, remaining at that level through 2025. The Fed’s projections for economic growth indicate a 2.1% expansion this year, followed by a modest 2% growth in 2025, consistent with its June projections.

Long-Term Implications of the Fed’s Move

The rate cut marks the beginning of what analysts expect will be an extended period of monetary easing. This shift away from the rate hikes of 2022 and 2023 demonstrates the Fed’s growing confidence that inflation is no longer the primary threat to the U.S. economy.

However, this pivot also comes with risks. Some economists warn that cutting rates too quickly could reignite inflationary pressures, especially if supply chain disruptions or geopolitical factors resurface. Others argue that the Fed is wise to prioritize employment, particularly in an economy where wages have lagged behind inflation for much of the past two years.

The Fed’s balancing act between promoting economic growth and preventing inflation will define Powell’s legacy as chair. By opting for a bold rate cut now, Powell is signaling his willingness to take calculated risks to protect both employment and price stability.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

19th September, 2024