Fed Cuts Rates by 50bp in a Push to Avoid Recession

• Federal Reserve delivers a 50 basis point rate cut, aiming to avoid recession and stabilize economic growth.

• Despite the Fed’s jumbo rate cut, market reaction was muted.

The Fed Delivered a Larger-than-Usual Interest Rate Cut

On Wednesday, in a widely anticipated move, the Federal Reserve announced an outsized 50 basis point interest rate cut, reflecting a confidence in its ability to manage inflation and rising concerns about the health of the labour market, with the goal of averting a potential recession.

The Fed signalled the beginning of a series of rate reductions aimed at supporting economic growth and by next summer, the projections are for additional 150 basis points cuts.

While a rate cut was widely expected, the debate centred around its size in the lead-up to Wednesday’s announcement. Market speculation suggested that a larger cut could reflect the Federal Reserve's increasing concerns about the economy’s strength and future outlook.

Inflation and Employment Balance

In its statement, the Federal Open Market Committee (FOMC) emphasized increased confidence that inflation is moving toward the 2% target. Policymakers indicated that risks to both inflation and employment objectives are now more balanced.

Despite inflation remaining "somewhat elevated," the FOMC highlighted that the decision to lower rates by a larger 50 basis points was made in response to the progress on inflation and the rapidly slowing employment. The Fed also reaffirmed its readiness to adjust monetary policy if risks emerge that could obstruct its dual mandate - maintaining stable prices and maximum employment.

Future Rate Projections

Enthusiasm for future rate cuts was tempered by Fed Chair Jerome Powell’s remarks that the central bank does not intend to return to the era of ultra-low interest rates seen during the COVID-19 pandemic. While the Fed had previously slashed rates to near zero to mitigate the economic fallout, Powell indicated that the neutral rate going forward would be significantly higher than before.

The Federal Reserve projects further reductions in its benchmark interest rate, with an additional 50 basis points of cut expected by the end of 2024, followed by 100 basis points easing in 2025, and another 50 basis points cut in 2026, bringing the rate to a range of 2.75%-3.00%.

This endpoint represents a slight upward revision to the longer-term federal funds rate from 2.8% to 2.9%, a neutral stance that neither stimulates nor constrains economic activity.

Source: Federal Reserve Board

Economic Projections

Inflation, currently 0.50% above the Fed’s 2% target, is forecasted to decline to 2.3% by the end of 2024 and further to 2.1% by the end of 2025. The unemployment rate is expected to rise slightly to 4.4% by the end of the year, with economic growth projected at 2.1% for 2024 and 2.0% for 2025 - unchanged from previous forecasts.

Market Reaction to the Jumbo rate Cut was Muted

US equity markets initially cheered the aggressive interest rate cut and jumped on the news but have erased all of the gains throughout the trading session. Perhaps the market reaction was muted because the stock market has rallied strongly ahead of the Fed’s decision.

Nonetheless, the Fed’s commitment to avoid a hard landing and its willingness to adjust drastically the policy stance (if needed) in order to achieve long-term economic stability, could trigger a stock market rally to new record highs in the months ahead.

Conclusion

The Fed’s aggressive rate cut aims to prevent a recession. While the central bank seeks to stabilize the economy, the labour market remains a concern. If growth weakens further, the Fed could cut rates even lower than the current neutral projections, given that a 3% policy rate is not considered stimulative for the economy.