In an unexpected move, the Federal Reserve, led by Jerome Powell, defied the expectations of the majority of economists by implementing a 50 basis point (bps) interest rate cut. Out of 113 surveyed economists, only 9 predicted such a significant cut, making the decision surprising to many. At the same time, the Fed adjusted its "dot plot" projections, which reflect the expectations for future rate hikes or cuts, and slashed these expectations. This shift was notable given that the Fed barely altered its growth and unemployment projections and remained hopeful about lowering inflation.
The timing of this decision—just two months before a major election—adds an extra layer of intrigue. Comparisons are being drawn to Arthur Burns, a former Fed chair whose policies in the 1970s were criticized for contributing to high inflation. Should the decision to cut rates have any political or economic fallout, the Fed could face blame if the incumbent wins the upcoming election.
Adding to the dovish sentiment, JPMorgan's AI-driven natural language processing tool evaluated the Fed's statement and deemed it to be quite dovish, signaling an overall softer stance on interest rates.
What Happened Since the Last FOMC Meeting?
Since the Federal Open Market Committee's (FOMC) last meeting on July 31, 2023, the economic landscape has been volatile. There were concerns over economic growth, data reports varied in strength, and the annual Jackson Hole symposium took place, all while the market became increasingly convinced that a 50bps rate cut was necessary. Despite this, many believed a recession wasn't imminent. Throughout this period, bonds and gold have significantly outperformed, while oil and the dollar have struggled.
In terms of market reaction, stocks and bonds seemed to diverge. Stocks remained mostly unchanged, signaling no immediate fear of a recession, while bond yields dropped sharply by 40-50bps, a sign that bond markets were pricing in an economic downturn. Interestingly, U.S. macroeconomic data came in stronger than expected, making the timing of a rate cut seem questionable to some.
Moreover, both growth and inflation data have surprised to the upside. However, despite inflation concerns, the Fed has opted to proceed with the rate cut. Rate-cut expectations have soared since the last FOMC meeting, with market participants now anticipating an additional 60bps worth of cuts by the end of 2025. Much of this expectation is concentrated on cuts expected in 2024.
Odds of a 50bps Cut Decline Leading Up to the Announcement
Before the Fed made its announcement, the odds of a 50bps cut had been gradually declining. Earlier in the day, the likelihood of such a cut dropped from 75% to 57%, signaling that many investors were growing less confident about the possibility of such a bold move.
The Fed's Decision and What It Means for the Future
When the decision was finally made, the Fed cut rates by 50bps, lowering the benchmark interest rate to a range of 4.75%-5.0%. This marked the first rate cut in over four years. Notably, Fed Governor Miki Bowman dissented, favoring a smaller 25bps cut. Her dissent is the first by a governor since 2005, which adds further weight to the significance of this meeting.
The Fed's official statement highlighted its strong commitment to both achieving maximum employment and bringing inflation back to its 2% target. Additionally, the statement indicated that the Fed would carefully assess incoming economic data and the evolving risks before making any further rate adjustments. The Fed also made slight tweaks to its language regarding the labor market, noting that job gains have slowed, and acknowledged that while inflation has made progress toward the 2% target, it remains somewhat elevated.
A Shift in the Fed's Dot Plot
Perhaps the most telling change came in the Fed's dot plot. The projections for future interest rates took a noticeable dip to align more closely with market expectations. The median projection for the federal funds rate in 2024 dropped from 5.125% to 4.375%, while the 2025 projection fell from 4.125% to 3.375%. Projections for 2026 were also reduced, from 3.125% to 2.875%. Of the 19 officials involved in the decision, nine penciled in rate cuts of 75bps or less over the next few years.
This shift in the dot plot marked a sharp departure from the Fed's expectations just a few months prior. For instance, at the Fed's June 2023 meeting, a significant portion of FOMC members had expected no rate cuts in 2024. Now, the consensus has moved decidedly toward multiple cuts over the next two years.
Despite this dovish shift in interest rate expectations, the Fed made only minimal changes to its growth and unemployment forecasts. The central bank left its 2025 GDP forecast unchanged and adjusted its unemployment rate forecast for that year from 4.2% to 4.4%. Additionally, the Fed slightly revised its core personal consumption expenditures (PCE) inflation forecast for 2025, lowering it from 2.3% to 2.2%.
What's Next?
With the Fed cutting rates despite a generally strong economic backdrop, the focus now shifts to what happens next. The Fed's statement made it clear that future rate decisions will depend on incoming data and evolving risks, meaning that additional rate cuts are not guaranteed. However, with the Fed's dot plot now more closely aligned with market expectations, investors will likely be watching closely for any signs of a shift in economic conditions that could prompt further rate cuts.
The Fed's decision also raises questions about the potential political implications of such a bold move so close to the upcoming election. Should the rate cut contribute to stronger economic growth or lower inflation, it could benefit the current administration. However, if the decision leads to negative economic consequences, the Fed could find itself in the political crosshairs.
Conclusion
The Federal Reserve's decision to cut interest rates by 50bps came as a surprise to many, especially given the relatively strong state of the U.S. economy. The central bank's decision to lower rates while barely adjusting its growth and unemployment forecasts raises questions about its long-term strategy and the potential political implications of its actions. As the economy continues to evolve, the Fed will face increasing scrutiny over its decisions, and the markets will be watching closely to see what comes next.
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