TLDR:
- Fed expected to cut interest rates for the first time in 4 years
- Markets split between 25 and 50 basis point cut expectations
- Rate cut marks end of aggressive inflation-fighting campaign
- New era of easier monetary policy expected through 2025-2026
- Fed to release updated economic projections and “dot plot”
The Federal Reserve is set to enter a new era of monetary policy this week as it prepares to cut interest rates for the first time in four years.
The central bank’s Federal Open Market Committee (FOMC) will conclude its two-day meeting on Wednesday, with markets widely expecting a rate cut that will mark the end of the most aggressive inflation-fighting campaign since the 1980s.
As of Monday, September 16, 2024, traders were split on whether the Fed would opt for a 25 or 50 basis point cut. The CME FedWatch Tool showed a roughly 49% probability for a 50 basis point reduction, up from just 28% a day earlier.
This indecision reflects the complex economic landscape the Fed must navigate, balancing concerns about persistent inflation with signs of a cooling labor market.
The potential rate cut comes at a critical juncture for the U.S. economy. Recent data has shown inflation continuing to edge lower, with the Consumer Price Index (CPI) rising at 3.2% in August, down from its peak but still above the Fed’s 2% target.
Meanwhile, the job market has shown signs of softening, with monthly job gains decelerating over the summer to levels below the average of the past year.
Fed Chair Jerome Powell has signaled a shift in focus, emphasizing the importance of supporting a strong labor market while making progress on price stability. In his August speech in Jackson Hole, Wyoming, Powell noted that the current policy rate gives the Fed “ample room” to lower rates in response to any weakening in the job market.
Alongside the rate decision, the Fed will release its Summary of Economic Projections, including the closely watched “dot plot” that maps out policymakers’ expectations for future interest rates. This will provide crucial insight into how aggressively the Fed plans to cut rates over the coming years.
Economists expect the Fed to chart a course for lower rates through 2025 and 2026. Luke Tilley, chief economist at Wilmington Trust, predicts the Fed will indicate two more 25 basis point cuts this year, followed by cuts at six out of eight policy meetings next year.
However, he cautions that the economy remains vulnerable to shocks, citing potential risks from oil price spikes, stock market plunges, or policy changes following the upcoming presidential election.
The implications of the Fed’s decision will ripple through the economy. Lower interest rates typically make borrowing cheaper for consumers and businesses, potentially stimulating spending and investment. However, the Fed must balance this stimulus against the risk of reigniting inflationary pressures.
Wednesday’s meeting will also be closely watched for any signals about the pace and size of future rate cuts. Some Fed officials, including Governor Chris Waller, have expressed openness to larger cuts if economic data warrants such action.
The rate decision comes roughly six weeks before the presidential election, a timing that has drawn criticism from some politicians who argue the Fed should refrain from major policy changes so close to the vote.
However, the Fed maintains its independence and bases its decisions on economic data rather than political considerations.
As markets await the Fed’s decision, volatility is expected. The S&P 500 and Nasdaq Composite both recorded their best week of the year last week, with gains of 4% and 6% respectively, as investors positioned themselves ahead of the crucial policy meeting.
