The Federal Reserve cut interest rates for the first time in years as inflation keeps cooling
The Federal Open Market Committee voted Wednesday to lower interest rates by 50 basis points, bringing the federal funds rate down from two-decade highs after more than a year of watching and waiting.
Interest rates are now set at 4.75%-5.0%. The half-point reduction is on the larger end of projections, in line with fed funds futures markets expectations. It also marks the first time the Fed has lowered rates since March 2020.
The committee attributed the aggressive cut to both progress on inflation and the balance of risks associated with higher-for-longer rates.
“The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” the Fed said in a statement. “The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.”
Fed Governor Michelle Bowman was the only committee member to vote for a quarter-point cut.
Chair Jerome Powell said in a press conference following the announcement that the half-point cut will help the Fed continue to balance the decreased risk from inflation and increased risk stemming from the unemployment rate, which has been trending upwards.
“This recalibration of our policy stance will help maintain the strength of the economy and the labor market, and will continue to enable further progress on inflation as we begin the process of moving toward a more neutral stance,” Powell said.
He added that this “good, strong start” is a sign that the committee is confident that inflation is heading towards its 2% target.
When the Fed began tightening monetary policy in March 2022, consumer prices had risen 8.5% on the year. As of July 2023, when the Fed set the current 5.25%-5.5% rate, inflation had already fallen to 3.2%.
For most Fed watchers, it was high time to carry out a cut, after the central bank launched its historic interest rate hiking campaign more than two years ago. In August, overall inflation rose just 2.5% over the past year, a considerable sign of cooling. And unemployment, which jumped to 4.3% in July, stayed at around 4.2% last month — still creeping above earlier projections.
In its updated Summary of Economic Projections, the Fed cut its projections for core Personal Consumption Expenditures, the Fed’s preferred inflation metric, to 2.3% from 2.6% in June, and the median for next year to 2.1% from 2.3%.
The committee adjusted its median unemployment rate projection to 4.4% by the end of this year, and 3.4% at the end of 2025. Powell also noted a median projection of 2% GDP growth over the next few years. The Fed chair said these projections are consistent with lower inflation and higher unemployment.
The committee acknowledged in its announcement that while economic activity has continued at a healthy pace, “job gains have slowed, and the unemployment rate has moved up but remains low.”
The highly anticipated cut initially sent markets upwards, before reversingcourse. The Dow closed down over 100 points, while the S&P 500 lost 16 points, and the tech-heavy Nasdaq fell nearly 55 points.
What comes next?
Analysts are expecting between a 75 to 100 basis-point reduction to the federal funds rate by the end of this year, spread across at least three or four cuts. But until further reductions are carried out, Americans shouldn’t expect to see major changes to their finances or the economy, according to Bankrate chief financial analyst Greg McBride.
“Importantly, this rate cut is just the beginning,” McBride said. “By itself, one rate cut isn’t a panacea for borrowers grappling with high financing costs and has a minimal impact on the overall household budget. What will be more significant is the cumulative effect of a series of interest rate cuts over time.”
With that in mind, the Fed will be keeping a close eye on the labor market to determine its next move. While it’s believed that much of the recent surprise uptick in the unemployment rate is an adjustment to a surge in immigration in the first half of this year — which has already slowed sharply — job growth has shown signs of slowing.
“Whatever the jobless rate turns out to be for September, the number of jobs created will have tremendous political impact and tremendous impact in terms of what the Fed’s next steps might be,” David Dietze, senior investment strategist at Peapack Private Wealth Management (PGC), said in an interview.
Goldman (GS) analysts said in a research note, however, that they are “not too concerned because layoffs remain low, job openings remain high, GDP is growing at a healthy pace, and there have not been any major negative shocks.”
Chicago Federal Reserve President Austan Goolsbee previously told Quartz that higher-for-longer rates could cause deterioration in the job market down the line, although he hopes it has cooled to levels that are sustainable.
“But when, in the past, that starts to turn sour, it does so quickly,” he said. “And that’s the fear, that unemployment has drifted up now a fair amount, and it’s supposed to settle at a steady state, full employment level.”
The trajectory of inflation is the next-biggest thing to watch, as the metric has been on a steady path towards the Fed’s target levels. The consumer will also be a key indicator, with credit card delinquencies on the rise and early signs of an inflation-weary population.
For Americans, the top financial action they plan to take now that interest rates are lower is to buy a car, since lower interest rates on car loans would mean smaller monthly car payments, according to a recent NerdWallet (NRDS) survey. That’s followed by investing some of their savings and refinancing a loan, all of which become less costly.
Erica Groshen, senior economics advisor at Cornell University and former vice president of the Federal Reserve Bank of New York, warned, however, that interest rates may not return to pre-pandemic levels, in part because the Fed is in the process of reducing its balance sheet.
“That is, by its nature, contractionary,” she said. “It’s like having higher interest rates, and contributes towards that. So that could argue for them needing to, ironically, reduce interest rates a little bit faster now, but also that the final interest rate may end up being higher than it was in the 2010s.”
