The Fed has cut the federal funds rate for the first time in four years. The bold 0.5 percentage point cut was more than consensus expected and brings the target range for the fed funds rate to 4.75– 5%. The Fed’s mandate is to ensure maximum employment and price stability. However, the FOMC said in a statement that recent indicators suggested that while economic activity has continued to expand at a solid pace, job gains have slowed and unemployment increased, justifying the stimulus measure.
Inflation has meanwhile declined further towards its 2 per cent target. But the stickiest components of inflation remain high, and at Fathom we think that while inflation will decelerate over time, it won’t happen as rapidly as the Fed predicts. Our expectation for growth is also slightly more muted.
The background to Wednesday’s cut is of course the Fed’s significant tightening of policy over the past three years as it struggled to bring inflation under control, after the twin shocks of the pandemic and the Russia-Ukraine war. This aggressive tightening cycle saw rates climb 525 basis points between March 2022 and July 2023 — the fastest in 40 years. However, the committee’s decision to ease rates now indicates that it has more confidence that inflation will be brought firmly towards 2 per cent. In order to rebalance monetary policy, the committee has said it will continue to monitor the implications of incoming information for the economic outlook.
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Jay Powell, the chairman of the Fed, said on Wednesday that the US economy was “in a good place” and the committee’s decision on the rate was “designed to keep it there”. The Fed has been aiming to avoid a recession and secure a ‘soft landing’ for the US economy. Real GDP increased at an annual rate of 3 per cent in the second quarter of 2024, according to the US Bureau of Economic Analysis. In the first quarter, real GDP increased by 1.4 per cent, a rise that primarily reflected increases in consumer spending, private inventory investment, and non-residential fixed investment. These movements were partly offset by a downturn in residential fixed investment. In Fathom’s view, the US economy is likely to avoid recession, but it is not guaranteed — indeed, we see a one-in-three chance of a contraction in four-quarter US output by the end of 2025.
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Other central banks too have cut interest rates in recent weeks, in the belief they are winning the inflation battle. The European Central Bank cut by 25 basis points on 12 September and, while the Bank of England held its rate steady at 5% on 19 September after cutting by 0.25% on 1 August, it is expected to ease once more in December. US headline inflation is currently at 2.5% and markets expect the Fed will continue to cut should inflation continue to fall sustainably; and remain under control over the long term.
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US Treasury yields moved lower this week in anticipation of the rate cut. 10-year Treasury yields fell to their lowest level since last July, ending last week down -6 bps, at 3.65%. 2-year yields fell by a similar amount, to reach a two-year low of 3.58%. That took the yield curve up to a positive slope of 7 bps. The FOMC’s statement said it will continue reducing its holdings of Treasury securities and agency debt, and agency mortgage‑backed securities.
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Investors seemed to welcome the Fed’s decision. US and European stocks opened higher on Thursday morning. The S&P rose 1.51% towards market close with stocks also edging higher in London, Frankfurt and Tokyo. The expectation is for easing to continue further at the next meeting of the FOMC. Fathom thinks inflation will be stickier than they predict, but that it will eventually converge to target.
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The views expressed in this article are the views of the author, not necessarily those of LSEG.
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