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In a move that was widely anticipated, the Federal Open Market Committee (FOMC) opted on Wednesday to cut its fed funds interest rate by 50 basis points to a new target range of between 4.75% and 5%.
Wednesday’s rate cut marks the first time the Federal Reserve has changed its interest rate target since July 2023 and the first time it has lowered rates since the COVID-19 pandemic began in March 2020. The Fed’s rate cut likely means interest rates will continue to drop in the months ahead, but investors and economists remain uncertain about the pace of FOMC rate cuts moving forward.
Other Fed Moves
In addition to the interest rate decision, the Federal Reserve also said it will continue to allow up to $25 billion in Treasury securities and $35 billion in agency mortgage-backed securities (MBS) to mature and roll off its more than $7.1 trillion balance sheet per month.
U.S. inflation is now well below peak levels in 2022, allowing the Fed to take its foot off the gas pedal and begin easing monetary policy. For more than a year, the Fed has delayed an interest rate cut over concerns about choppy and inconsistent inflation data. Wednesday’s rate cut suggests Fed officials are finally convinced they have won the battle against inflation and should now shift their attention to supporting a softening labor market.
The first rate cut in four years is a milestone for the Fed, but the next several months will be critical in assessing whether or not the FOMC can achieve a “soft landing” for the economy. If the FOMC cut interest rates too soon, it could facilitate a rebound in inflation and undermine years of progress. But if the Fed waited too long to cut rates, the economy could still slip into a recession.
Markets reacted positively to the Fed’s policy decision on Wednesday, with the S&P 500 trading one-half percent higher on the day.
The Inflation Tightrope
Lower interest rates decrease borrowing costs for both companies and consumers, stimulating economic activity. Unfortunately for the Fed, a stronger economy can exacerbate inflation.
Earlier this month, the Labor Department reported the consumer price index (CPI) rose 2.5% year-over-year in August, down from a 2.9% gain in July and well below a 40-year high of 9.1% in June 2022. Food and shelter inflation remain stubbornly high, but lower energy prices have helped ease overall price growth.
In late August, the Commerce Department reported the Fed’s preferred inflation measure — the personal consumption expenditures (PCE) price index was up 2.6% year-over-year in July, in-line with its 2.6% gain in June and down from a 2022 peak of 5.3%. The Fed’s long-term target for core PCE inflation is 2%.
“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 FOMC said in its statement on Wednesday.
Jobs Market Remains Historically Strong But Weaker Than Projected
The Labor Department reported the U.S. economy added 142,000 jobs in August, missing economist expectations of 161,000 new jobs. Average U.S. wages were up 3.8% from a year ago and up 0.4% compared to July. August marked the fourth month out of the last five in which job growth has come in below 200,000.
The U.S. unemployment rate ticked down to 4.2%, but the U-6 unemployment rate reached 7.9%, its highest level since October 2021. The U-6 unemployment rate includes Americans working part-time jobs who would prefer full-time jobs and discouraged workers who have given up seeking employment.
In The Fed’s Own Words
In his post-meeting press conference on Wednesday, Fed Chair Jerome Powell said the large rate cut is not a sign the Fed waited too long to begin easing policy and is now forced to play catch-up.
“We don’t think we’re behind–we think this is timely. But I think you can take this as a sign of our commitment not to get behind,” Powell said.
“We’ve waited, and I think that patience has really paid dividends in the form [of] our confidence that inflation is moving sustainably down to 2%.”
Economic Projections
In addition to its monetary policy decisions, the Federal Reserve also updated its long-term economic projections on Wednesday. Committee members estimate a year-end median fed funds rate of 4.4% in 2024, down from their previous projection of 5.1% back in June. The latest rate projections suggest another 50 basis points in rate cuts by the end of 2024.
The Fed’s “dot plot” depiction of individual members’ interest rate expectations indicates nine of the 19 FOMC members believe rates should drop another 25 basis points or less by the end of the year.
The committee projects a 2024 U.S. unemployment rate of 4.4%, up from 4% in June. Fed members cut their 2024 U.S. gross domestic product (GDP) growth projection from 2.1% to 2%. The Federal Reserve also maintained its 2025 GDP growth projection of 2%.
On the inflation front, the Fed’s projected 2024 core PCE inflation growth rate dropped from 2.8% to 2.6%.
Stock Market Jumps For Rate Cuts
Some investors have been concerned the Fed waited too long to begin cutting interest rates and the lagging economic impact of higher rates will ultimately trigger a recession. Despite a strong year-to-date performance by the S&P 500, the New York Fed’s recession probability model still estimates a 61.7% chance of a U.S. recession sometime in the next 12 months.
Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, says an aggressive Fed opens the door for the S&P 500 to rally to new all-time highs.
“The Fed front-loaded this rate cutting cycle with a jumbo 50 bps rate cut and signaled in their statement that they are focused squarely on the labor market, saying they are ‘strongly committed to supporting maximum employment,” Zaccarelli said.
“Although they pay lip service to the other part of their dual mandate (i.e. inflation), clearly they have taken their eye off that ball,” Zaccarelli continued. “And although inflation is much lower now than the peak we saw in 2022, igniting a stock market rally and goosing a growing economy with lower rates risks letting inflation come roaring back before this bull market ends.”
Stock Market Jumps For Rate Cuts
According to CME Group, markets are currently pricing in a 64.1% chance the Fed will issue an additional 25 basis-point rate cut at its next meeting, which concludes on November 1. However, investors and central bankers have roughly six weeks of economic data to monitor between now and then that could significantly impact monetary policy.
Quincy Krosby, chief global strategist for LPL Financial, says the Fed’s larger rate cut suggests it is concerned about risks to the labor market.
“Equity markets applauded the Fed’s decision to initiate its easing cycle with 50 basis points, as the statement noted that the Fed’s dual mandates are in balance,” Krosby says.
“Given how much discussion has surrounded this move, the announcement certainly wasn’t a surprise;, however, the lack of guidance by Fed officials indicates that although there was only one dissent there must have been a forceful discussion and work towards building a consensus.”
In the near term, investors will be watching for the August core PCE reading on September 27 to see if inflation is still trending lower heading into the fourth quarter. In addition, the University of Michigan Consumer Sentiment Index reading on September 27 will provide some critical insight into the health of the U.S. consumer.
Federal Open Market Committee (FOMC) FAQs
What is the Federal Reserve?
The Federal Reserve is the central bank of the United States, and is generally considered to be the most powerful central bank in the world. Often referred to as the Fed, it was founded to direct monetary policy and manage the financial system. A seven-member board governs the Fed, and there are 12 Federal Reserve Banks in regions throughout the U.S.
The Federal Open Market Committee (FOMC) is the main policy making body of the Fed. The FOMC sets the federal funds target rate and makes other monetary policy decisions for the Fed. The FOMC meets eight times a year to vote on interest rates and policy priorities.
There are 12 members of the FOMC:
- The seven members of the Fed Board of Governors, led by Fed Chair Jerome Powell.
- Five of the 12 Federal Reserve Bank presidents, although the head of the Federal Reserve Bank of New York is a permanent member of the FOMC. The other four voting positions are filled on a rotating basis by the presidents of the other Federal Reserve Banks across the country. Even though most presidents don’t vote, they can all attend the meetings and debate policy.
When is the next FOMC meeting?
The next FOMC meeting is scheduled for June 11-12. The FOMC hold eight scheduled meetings a year, one every six weeks or so. The committee can also meet whenever it feels necessary and believes that it needs to act, such as during a financial crisis.
When are the FOMC minutes released?
The FOMC releases minutes of its meetings three weeks after the most recent meeting. A full transcript isn’t available for a full five years after a meeting.
How many times will the FOMC cut rates in 2024?
The FOMC raised interest rates 11 times from 2022 to 2023, putting the federal funds target rate at 5.25% to 5.50%. However, the Fed has not rasied rates since July 2023.
The CME Group’s FedWatch tool shows a better than 60% chance the Fed will cut rates by its September meeting.