In a significant shift to support the U.S. economy, the Federal Reserve slashed its benchmark interest rate by half a percentage point on Wednesday. This decisive move marks the start of a policy change aimed at strengthening the labor market and steering inflation closer to the Fed’s target.
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Following the Fed’s two-day meeting, projections revealed a split among officials. A narrow majority, 10 out of 19 members, supported at least an additional half-point rate cut during the remaining two meetings in 2024. The Federal Open Market Committee (FOMC) voted 11-1 to lower the federal funds rate to a range of 4.75% to 5%, a level that had been maintained for more than a year and was the highest in two decades.
“This decision reflects our growing confidence that with an appropriate recalibration of our policy stance, strength in the labor market can be maintained in a context of moderate growth and inflation moving sustainably down to 2%,” Fed Chair Jerome Powell remarked at a press conference following the announcement. He emphasized that this half-point cut should not be seen as a sign of a new trend in policy moves.
The Fed’s statement highlighted that policymakers view the risks to employment and inflation as “roughly balanced.” The committee reaffirmed its commitment to maximizing employment while also focusing on bringing inflation back to its 2% goal.
Market Reaction: The S&P 500 index climbed in response to the rate cut, while Treasury yields and the Bloomberg Dollar Index fell, signaling a positive market reception.
Future Rate Adjustments: According to the FOMC’s median forecast, an additional percentage point in rate cuts is expected in 2025. Governor Michelle Bowman dissented, favoring a smaller quarter-point cut. This marked the first dissent by a governor since 2005 and the first by any FOMC member since 2022. Diane Swonk, Chief Economist at KPMG, pointed out that Powell’s willingness to push for an aggressive cut despite dissent indicates “how much he wanted this half-point rate cut.”
Policymakers mentioned in their statement that they would consider “additional adjustments” to rates based on “incoming data, the evolving outlook, and the balance of risks.” They also noted that while inflation remains “somewhat elevated,” job gains have slowed down.
Economic Forecasts: The Fed’s quarterly economic forecasts were adjusted, with the median unemployment projection for the end of 2024 rising to 4.4% from the previous 4% forecast in June. This would represent a slight increase from the current unemployment rate of 4.2%. The median inflation forecast for 2024 dipped to 2.3%, while the median projection for economic growth decreased to 2%. Policymakers still do not foresee inflation hitting the 2% target until 2026. Additionally, the long-term federal funds rate projection was revised upward to 2.9% from 2.8%.
The New Chapter for the Fed: This rate cut opens a new chapter for the Federal Reserve, which began raising borrowing costs in early 2022 to combat the inflationary pressures brought on by the pandemic. Inflation, exacerbated by supply-chain disruptions and a surge in consumer demand, had surged to its highest level since 1981. The central bank responded by hiking rates 11 times, bringing the federal funds rate to a two-decade high by July 2023.
Since then, inflation has cooled significantly, now sitting at 2.5%, just shy of the Fed’s 2% target. Although the labor market has shown signs of weakness, there is no definitive evidence that the U.S. economy is entering a recession. Layoffs remain low, consumer spending continues, and economic growth remains robust.
Risks and Outlook: Despite these positive signs, some economic strains are beginning to emerge. Excess savings that have bolstered American households in recent years are depleting, and delinquency rates are on the rise. A potential increase in job losses could curb consumer spending, thereby slowing economic growth.
This complex economic backdrop has created uncertainty and differing views among Fed officials on the future direction of policy. Some members are keen to address labor market weakness swiftly to avoid a downward spiral, while others caution that cutting rates too aggressively could reignite demand and keep inflation above the desired levels.