The Federal Reserve’s 50 basis point rate cut on Wednesday caught markets off guard, as most economists and market participants had expected a 25 point move. This decision marks the first interest rate cut since 2020, signaling the start of a new easing cycle. The move highlights concern that monetary policy may have been too tight, particularly given the rise in unemployment forecasts.
Meanwhile, the Fed sees inflation risks as having moderated, allowing them to adopt a more aggressive first rate cut to sustain growth and employment. Seemingly, Fed Chair Powell got what he wanted based on reading between the lines of his press conference in July and his August Jackson Hole comments. An aggressive rate cut to kick off this easing regime gives the Fed optionality to react to another bad jobs number between now and the November meeting.
What Stands Out for Us
- Unexpected Size: Chair Powell emphasized that the 50-point cut in interest rates this week should not set a precedent for future actions, leaving room for a slower pace depending on economic data. However, Powell indicated a shift toward an easing regime, stating that the Fed had made a “good, strong start.”
- Unusual Dissent Within the Fed: Fed Governor Michelle “Miki” Bowman dissented, preferring a 25-point cut. This is the first dissent in this typically consensus-driven group since 2005. There was also significant disagreement in interest rate projections (the “dot plot”) for 2025, with a 125 point spread in projections. Despite the dissent, it is unlikely to influence future decisions.
- Interest Rate Projections 2024-2025: The Fed is currently projecting that the Federal funds rate will reach 4.38% by the end of 2024, implying two more 25 point cuts, likely at the November and December meetings. The dot plot also indicates an additional 100 points of cuts in 2025, which is slightly less aggressive than market expectations. The Fed raised its longer-term neutral rate projection to 2.9%, indicating expectations of higher rates for a prolonged period.
- Labor Market Concerns: Rising unemployment is increasingly on the Fed’s radar, with year-end unemployment projections revised 40 basis points higher than the June estimate. Projections for 2025 and 2026 were also revised upward. The Fed’s statement highlighted its commitment to “sustaining maximum employment,” signaling a shift in focus from inflation risks to concerns about the labor market. Despite this, Powell maintained that the labor market remains in “solid condition” and that the Fed intends to keep it that way.
- Recent Market Reaction: After a bit of choppiness yesterday, the markets have overall reacted positively to the rate cut. Treasury yields have risen slightly, indicating that bond markets remain cautious about the future path of interest rates and the potential for higher inflation if the Fed cuts too aggressively. Notably, the VIX volatility index finished above 18 yesterday, up three-quarters of a point on the day and consistent with our view that volatility is likely to remain elevated.
- Historical Market Reaction: Historically, asset classes, including bonds, have performed positively after the first rate cut in a cycle. However, stock market performance has been mixed, depending on broader economic conditions. Bonds have tended to deliver stronger-than-average total returns in the year following the first cut in a cycle.
