WASHINGTON — The Federal Reserve on Wednesday made its first interest rate cut since the early days of the Covid pandemic, cutting half a percentage point from the benchmark interest rate in an effort to head off a slowdown in the labor market.
With both the jobs picture and inflation weakening, the central bank’s Federal Open Market Committee opted to cut its key overnight rate by half a percentage point, or 50 basis points, reaffirming market expectations that had recently shifted from a prospect of a halving of that interest. mate.
Aside from the emergency cuts during the coronavirus crisis, the last time the FOMC cut rates by half a point was in 2008, during the global financial crisis.
The decision lowers the federal funds rate to a range between 4.75% and 5%. While interest rates determine borrowing costs for banks in the short term, it extends to multiple consumer products such as mortgages, car loans and credit cards.
In addition to this cut, the commission indicated through its dot plot the equivalent of a further 50 basis points of cuts by the end of the year, close to the market price. The matrix of individual officials’ expectations pointed to another full percentage point of cuts by the end of 2025 and a half point in 2026. Overall, the dot chart shows the benchmark rate falling about 2 percentage points after Wednesday’s move.
“The Committee has grown in confidence that inflation is moving sustainably towards 2 percent and believes that the risks to achieving employment and inflation targets are approximately balanced,” the statement after the meeting said.
The easing decision came “in light of progress on inflation and the balance of risks.” Notably, the FOMC vote was 11-1, with Governor Michelle Bowman favoring a quarter-point move. Bowman’s dissent was the first from a Fed governor since 2005, although a number of regional presidents have voted no during that period.
“We are trying to get to a situation where we restore price stability without the kind of painful rise in unemployment that sometimes accompanies this inflation. That’s what we’re trying to do, and I think you could take today’s action as a sign of our strong commitment to achieving that goal,” Chairman Jerome Powell said at a news conference after the decision.
Trading was volatile following the decision, with the Dow Jones Industrial Average rising as much as 375 points after the release, before easing somewhat as investors digested the news and considered what it suggests about the state of the economy.
Stocks closed slightly lower that day, while government bond yields rebounded higher.
“This is not the start of a series of 50 basis point cuts. The market thought to itself: if you go to 50, there is a good chance that another 50 basis points will be added. But I think so [Powell] That idea has really been undermined to some extent,” said Tom Porcelli, chief US economist at PGIM Fixed Income. “It’s not that he doesn’t think that’s going to happen, it’s that he hasn’t committed in advance that it will will happen. That’s the right call.”
The committee noted that “job growth has slowed and the unemployment rate has increased, but remains low.” FOMC officials raised their projected unemployment rate to 4.4% this year, up from the 4% projection at the last update in June, and lowered the inflation outlook to 2.3% from 2.6% previously. On core inflation, the committee lowered its projection to 2.6%, down 0.2 percentage points from June.
The committee expects long-term neutral rates to be around 2.9%, a level that has risen as the Fed has struggled to bring inflation down to 2%.
The decision comes despite the fact that most economic indicators look quite solid.
Gross domestic product has been rising steadily and the Atlanta Fed expects 3% growth in the third quarter based on continued strength in consumer spending. Moreover, the Fed has chosen to cut spending even though most indicators show inflation is well above the central bank’s 2% target. The Fed’s favorite measure shows inflation at around 2.5%, well below peak but still higher than policymakers would like.
However, Powell and other policymakers have expressed concerns about the labor market in recent days. While layoffs show little sign of recovery, hiring has slowed significantly. The last time the monthly hiring rate was this low – 3.5% as a percentage of the labor force – the unemployment rate was even above 6%.
At his press conference after the July meeting, Powell noted that a 50 basis point cut “is not something we are thinking about right now.”
At least for now, this move helps resolve a contentious debate over how strong the Fed should have been with the initial move.
However, it sets the stage for future questions about how far the central bank must go before it stops cutting spending. There was a great divide among the members about the direction they see going in the coming years.
Investors’ conviction on this wavered in the days leading up to the meeting. Over the past week, the odds had shifted to a half-point cut, with the 50 basis point probability at 63% just before the decision, according to the CME Group report. FedWatch meter.
The Fed last cut rates on March 16, 2020, as part of an emergency response to an economic shutdown caused by the spread of Covid-19. The increase started in March 2022, when inflation climbed to the highest level in more than four decades, and interest rates were last raised in July 2023. During the tightening campaign, the Fed raised rates by 75 basis points four times in a row.
The current unemployment level is 4.2% and has increased over the past year, but is still at a level that could be considered full employment.
“This was an atypical large cut,” Porceli said. “We are not knocking on the door of a recession. This easing and this small cut is about recalibrating policy due to the fact that inflation has fallen so much.”
With the Fed at the center of the global financial universe, Wednesday’s decision is likely to resonate with other central banks, several of which have already started cutting spending. The factors driving up global inflation were mainly related to the pandemic: crippled international supply chains, excessive demand for goods rather than services, and an unprecedented influx of monetary and fiscal stimulus.
The Bank of England, the European Central Bank and the Central Bank of Canada all recently cut rates, although others waited for the Fed’s signal.
While the Fed approved the rate cut, it maintained a program of slowly reducing the size of its bond holdings. The process, nicknamed “quantitative tightening,” has reduced the Fed’s balance sheet to $7.2 trillion, down about $1.7 trillion from its peak. The Fed is allowing up to $50 billion in maturing Treasuries and mortgage-backed securities each month, down from the initial $95 billion when QT began.