Fed cuts 50 bps; Markets slip lower into the close

The Federal Reserve’s decision to cut interest rates by 50 basis points on September 18 was widely expected, marking the first reduction since March 2020. This bold move signals the Fed's urgency in providing relief from elevated borrowing costs, as inflation has moderated without triggering a recession. However, the decision wasn't unanimous—Governor Michelle Bowman dissented, preferring a smaller 25 basis point cut. This rate cut, aimed at lowering borrowing costs across sectors like mortgages and credit cards, underscores the Fed’s commitment to easing financial conditions to support the economy.

Markets initially reacted postively to the decision as S&P futures popped to 5730 following the announcement. However, buyers were not able to establish ground above that level. This eventually led to some profit taking and foir futures to slip lower, closing near the session lows.

One of the notable changes in the Fed’s September statement was its increased confidence in inflation moving towards its 2% target. This contrasts with the July statement, where inflation was described as "somewhat elevated" but with progress. In September, the Fed maintained its view that inflation remains elevated but indicated further progress toward its goal, showing more optimism about the trajectory of price stability. Economic growth was still described as expanding at a “solid pace,” while the labor market was characterized as showing slower, but still strong, job gains.

The Fed's updated Summary of Economic Projections (SEP) reveals a shift in expectations, most notably with a projection for another 50 basis points of rate cuts by the end of the year. This is a departure from the June SEP, where the Fed forecasted only one rate cut in 2024. The new projections suggest that the central bank is more focused on ensuring financial conditions remain supportive of economic stability, while still guarding against inflation risks.

Changes in the Fed’s dot plot, which reflects individual policymakers' views on the future path of interest rates, were also significant. The September dot plot showed that most officials expect the Federal Funds rate to end 2024 at around 4.4%, compared to 5.1% projected in June. This suggests that policymakers see a path of more substantial rate cuts ahead, as inflation pressures ease and economic risks shift toward potential labor market softness.

The Fed’s inflation outlook has also improved, with 2024 projections for the Personal Consumption Expenditures (PCE) inflation falling from 2.6% in June to 2.3% in September. Core PCE inflation, which excludes volatile food and energy prices, was similarly adjusted downward to 2.6% for 2024, indicating the Fed expects inflation to moderate more quickly than previously thought. However, the unemployment rate for 2024 was revised upward to 4.4% from 4.0%, reflecting potential concerns about a cooling labor market.

The forward guidance included in the September SEP suggests that the Fed is prepared for additional cuts, potentially by another 50 basis points, as it navigates through the final months of 2024. This projection highlights the central bank's shift from inflation control toward stabilizing the broader economy, especially amid rising unemployment concerns. Importantly, the Fed maintained its long-run neutral rate projection of 2.9%, suggesting that officials believe rates will return to more normalized levels once inflation and economic conditions stabilize.

During his Q&A session, Powell emphasized that the Federal Reserve’s decision to cut rates by 50 basis points was a recalibration of policy to align with a more neutral stance. He addressed concerns about a potential recession, stating that the risks to the economy are now more balanced than they had been during the period of aggressive inflation control. Powell highlighted that inflation is coming down and the labor market, while cooling, remains solid, which supported the decision to shift towards a less restrictive monetary policy. He reassured markets that, despite the rate cut, there were no imminent signs of an economic downturn.

When asked whether the 50 basis point cut was motivated by catching up to inflation or reacting to elevated nominal rates, Powell indicated that the Fed is not behind the curve. He described the cut as timely and noted that the Fed's patience in waiting to reduce rates had paid off by allowing inflation to moderate sustainably. Powell was clear that the move should not be seen as setting a precedent for more aggressive cuts but as a necessary step in adjusting policy to economic conditions. He highlighted the importance of monitoring future data to guide the pace of any further reductions.

A key takeaway from Powell’s comments was the Fed’s measured approach to rate cuts. He clarified that the Fed was not in a rush to make drastic moves, referencing the Summary of Economic Projections (SEP), which does not indicate urgency in further rate cuts. Powell explained that the SEP shows a gradual pace of cuts over time and reiterated that the Fed will remain flexible, adjusting its actions based on the evolving economic landscape, rather than committing to a predetermined course.

In response to the WSJ’s question on whether the Fed was influenced by recent employment data, Powell downplayed any significant changes in the data as a driving force for the rate cut. Instead, he reiterated that the focus remains on inflation control and overall economic conditions, which have allowed the Fed to take this step confidently. He stressed that the Fed's current trajectory is based on its base case of gradually reducing policy rates in a sustainable manner, with flexibility to respond to economic developments if needed.

In summary, the Fed's September decision underscores a pivotal shift toward easing financial conditions with more aggressive rate cuts expected before year-end. While inflation has shown progress, labor market concerns are rising, making the Fed’s balancing act between growth and inflation even more delicate. Investors and market participants will be closely watching the Fed’s next moves, particularly around further cuts and the evolving economic landscape.