The Fed has cut interest rates by 0.5%

Time for markets to pump

In a pivotal move, the Federal Reserve enacted its first interest rate cut on Wednesday since the early stages of the COVID-19 pandemic. The central bank reduced its benchmark interest rate by half a percentage point, aiming to mitigate an anticipated slowdown in the labor market amid easing inflation and softer employment figures.

The Federal Open Market Committee (FOMC), responsible for setting monetary policy, lowered the key overnight borrowing rate to a target range between 4.75% and 5%.

This decision matched recent market expectations that had shifted toward a larger cut, doubling the initially anticipated quarter-point reduction. Excluding emergency measures during the pandemic, this is the first half-point rate cut since 2008, when the Fed responded to the global financial crisis.

This rate adjustment affects short-term borrowing costs for banks and has a cascading impact on consumer financial products such as mortgages, auto loans, and credit cards.

Alongside the rate cut, the FOMC's "dot plot" projections signaled an additional 50 basis points of reductions by year's end, aligning closely with market forecasts. The projections also suggest a cumulative decrease of about two percentage points beyond this latest move over the coming years.

"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 stated in its post-meeting announcement. The decision was largely consensual, passing with an 11-1 vote.

Governor Michelle Bowman cast the sole dissenting vote, favoring a smaller quarter-point cut—a notable dissent as it's the first from a Fed governor since 2005.

Federal Reserve Chair Jerome Powell emphasized the central bank's commitment to restoring price stability without triggering significant unemployment. "We're trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with this inflation," Powell explained during a press conference. "Today's action is a sign of our strong commitment to achieve that goal."

Financial markets responded with volatility. The Dow Jones Industrial Average initially surged by up to 375 points following the announcement but later retreated as investors digested the implications. By the end of the trading day, stocks closed slightly lower, and Treasury yields experienced an uptick.

Analysts caution that this substantial rate cut doesn't necessarily indicate a series of similar future moves. Tom Porcelli, chief U.S. economist at PGIM Fixed Income, remarked, "This is not the beginning of a series of 50 basis point cuts. The market was thinking to itself, if you go 50, another 50 has a high likelihood. But I think [Powell] really dashed that idea to some extent."

The FOMC acknowledged that "job gains have slowed and the unemployment rate has moved up but remains low." Policymakers adjusted their unemployment rate projection for this year upward to 4.4% from the 4% estimated in June. They also revised the inflation outlook downward to 2.3% from the previous 2.6%, and slightly lowered the core inflation projection to 2.6%.

Despite robust indicators like steady gross domestic product growth—currently tracking at 3% for the third quarter according to the Atlanta Fed—the central bank opted for the rate cut due to concerns over weakening momentum in the labor market. While layoffs remain minimal, hiring has slowed significantly, with the monthly hiring rate at 3.5% of the labor force, a level previously associated with unemployment rates above 6%.

This decision marks a notable shift from Powell's comments in July, when he stated that a 50 basis point cut was "not something we're thinking about right now." The move settles some debates over the aggressiveness of the Fed's initial action but opens questions about the future path of monetary policy and the extent of further rate adjustments.

Investor sentiment fluctuated in the days leading up to the meeting, with the probability of a half-point cut rising to 63% just before the decision, according to CME Group's FedWatch tool. The last rate reduction prior to this was in March 2020 as part of emergency measures during the pandemic-induced economic shutdown.

As the Fed holds a central role in global finance, this rate cut may influence other central banks, many of which have begun or are considering easing monetary policies. Factors such as disrupted supply chains and unprecedented fiscal stimulus during the pandemic had driven global inflation higher, prompting coordinated responses.

While reducing rates, the Fed continues its "quantitative tightening" program, gradually decreasing its balance sheet by allowing up to $50 billion in maturing securities each month—a reduction from the initial $95 billion when the program began. This strategy will normalize the central bank's asset holdings following extensive stimulus efforts.

The rate cut reflects the Fed's delicate balancing act: fostering economic growth and employment without igniting inflation. As policymakers navigate these challenges, future monetary policy decisions will be closely watched by markets and international counterparts alike.