Update 811 — Fed Cuts Key Rate 50 Points;
Jumbo Pivot Amid Labor Market Concerns
The Federal Reserve finally cut interest rates today by 50 basis points, the first such cut since 2020. The Fed signaled that more cuts would come in its remaining meetings this year. The principal immediate beneficiaries are consumers with credit card balances, mortgagees, and small businesses with variable-rate debt.
Balancing “progress on inflation” with concern about a cooling labor market and increases in unemployment in recent months, the Fed compensated for rates held over the past year at the highest level in 20 years. Democrats in Congress hailed the aggressive rate cut, with Joint Economic Committee Chair Senator Martin Heinrich calling the move “a big win for families across the country.” More below…
Best,
Dana
Fed Cuts Rate by 50 BPs; More Cuts to Follow This Year
The Federal Reserve announced this afternoon that it will cut interest rates by 50 basis points (BPs) and projected additional cuts this year as it finally begins to bring interest rates down from a two-decade high. The decision to cut rates by 50 rather than 25 BPs comes as the labor market, though remaining quite strong, has begun cooling in the face of the elevated interest rates.
Today’s decision was broadly anticipated and came at the conclusion of the Federal Open Market Committee’s (FOMC) September meeting this afternoon. According to economic projections released following the meeting, FOMC members expect that if the economy continues to move as expected with inflation trending down and the labor market cooling, members will opt to cut the federal funds rate to 4.4 percent by the end of this year, following its meetings in November and December.
Economic projections are collected from each member of the Federal Reserve Board of Governors and each Federal Reserve Bank president and reflect their expectations of future economic outcomes and appropriate monetary policy, given their assessments of current economic data. Additionally, FOMC members projected that they would cut rates to 3.4 percent by the end of 2025.
In the FOMC’s last set of projections issued in June, officials had penciled in just one 25 BP cut for the remainder of this year, but recent data showing weakening in the labor market has led officials to better balance its dual mandate of price stability and maximum employment. In his press conference following the FOMC’s meeting today, Federal Reserve Chair Jerome Powell said that the FOMC’s decision to cut rates did not reflect alarm about labor markets, but that today’s interest cut is appropriately calibrated as the FOMC seeks to ensure that the strength of that market is maintained. Powell also noted that the FOMC does not view the labor market as a source of inflationary pressure. Powell did acknowledge, however, that “The labor market bears close watching, and we’ll be giving it that.”
In the past, the Fed has initiated its cycles of interest rate hikes and cuts with an incremental 25 BP adjustment in order to monitor the impact of such a change on inflation, the labor market, and the broader economy, before opting to adjust rates by 50 or 75 BPs in subsequent meetings. In other cases, particularly during periods of significant economic stress, the Fed has initiated interest rate cut cycles with a 50 BP adjustment.
The elevated interest rate environment of the last year has played a role in bringing inflation down but has weakened the labor market with it. Days after the FOMC’s last meeting in July, in which the FOMC opted to hold rates steady rather than initiate cuts, the July jobs report was released showing that the job gains had moderated and, more notably, that unemployment had ticked up. Labor market data released since then makes clear that, while the labor market remains strong, this cooling is part of a sustained and ongoing trend. Given that the Fed appears to have been at least a meeting behind in initiating rate cuts, a 50 BP cut today was consistent with its goal of achieving maximum employment and maintaining the strength of the broader economy.
Interest Rate Cut Comes as Labor Market Softens
The FOMC began raising the federal funds rate from near zero in early 2022 in an effort to combat rising inflation. The Committee raised rates to the 5.25 to 5.5 percent range in its most aggressive series of rate hikes since the 1980s and has opted to hold rates steady at this elevated level since last July. This afternoon’s cut brings the federal funds rate to the 4.75 to 5.0 percent range.
Since the FOMC initiated its current cycle of rate hikes, inflation has fallen from its peak of 7.1 percent in mid-2022 to 2.6 percent in July and has been moving steadily toward the Fed’s two percent target over the past months. But the labor market, which had been remarkably resilient in the face of the elevated interest rate environment, has begun noticeably cooling:
- Job growth over the three months through August averaged 116,000 jobs per month as compared to the three-month average of 211,000 jobs a year ago.
- The unemployment rate has risen to 4.2 percent, up from 3.8 percent a year ago.
Economic projections show that FOMC members expect that inflation will reach 2.3 percent by the end of this year, 2.1 percent by the end of next year, and the Fed’s target of 2.0 percent by the end of 2026. Members expect the unemployment rate will increase to 4.4 percent by December and remain steady next year, before falling to 4.3 percent in 2026.
Economic growth – as measured by real gross domestic product (GDP) – has also remained strong, with the American economy growing by a remarkable 2.8 percent on an annualized basis in the second quarter of this year, by 1.4 percent over the first quarter of this year, and by 2.5 percent in 2023. Economic projections show that FOMC members expect that the American economy will grow by an overall 2.0 percent this year, reflecting slower growth over the remaining quarters of 2024, and to grow by 2.0 percent next year and in 2026. Ensuring that growth remains strong is a key concern for the Fed as it aims to prevent stagnation.
Fed Should Continue Aggressive Cut Rate Cuts This Year
Ahead of this week’s meeting, Senators Elizabeth Warren (D-MA), John Hickenlooper (D-CO), and Sheldon Whitehouse (D-RI) sent a letter to Fed Chair Powell highlighting these risks and urging FOMC members to cut interest rates by 75 BPs this month. Although the Fed has yet to see inflation at its two percent target over the prior twelve-month period, cutting rates by at least 50 BPs in each of the FOMC’s two remaining meetings this year could avoid unnecessary pain for the labor market and avoid any risks that a higher-interest-rate environment could bring to the financial sector.
The Fed’s steep set of interest rate hikes – in which it increased rates eleven times between March 2022 and July 2023 – is having a lagged effect and will continue to ripple across the economy for months to come. Lags in its full impact that may be hard to see through current economic data. The continuing impact of elevated rates may expose the economy to risks that may be difficult to predict and successfully respond to, like the risk of some banks failing to effectively manage losses in their portfolios due to higher interest rates. As Powell has noted, interest rate cuts also have a lagged effect and will take time to fully impact the broader economy. Borrowers will not feel relief immediately as the borrowing costs they face will take time to fall.
Today’s 50 BP cut was much needed and means that a soft landing – taming inflation without triggering a recession – has all but been achieved. Over the coming weeks, the Fed will assess new inflation and labor market data and weigh the risks of holding interest rates at an elevated level for too long against those of loosening monetary policy before the economic data reflects progress toward its target outcomes. The FOMC will meet next on November 6 and 7.