The Fed’s Rate Cut: Growth ‘Insurance’

The Federal Reserve’s decision on 31 July to lower the target range for the federal funds rate by 25 basis points (bps) to 2.0%–2.25% marks the first policy rate cut in more than a decade. It had been well telegraphed, and was widely expected by us and by markets. Also as expected, the Fed’s statement left the door open to further rate cuts by noting that risks to the U.S. outlook remain.

Less expected was Fed Chairman Jerome Powell’s lack of emphasis on forward guidance during the post-meeting press conference. Indeed, Powell shied away from providing any specific guidance on the likely economic conditions that would warrant further easing. The 400-point drop in the Dow Jones Industrial Average as Powell spoke demonstrated the market’s surprise.

However, we find the Fed’s statement clear: The Fed will continue to watch economic developments and “act as appropriate to sustain the expansion.” We expect another rate cut as soon as September with possible additional cuts thereafter. Growth in U.S. manufacturing, investment, and exports is likely to fall further over the next several months, and the Trump administration’s latest announcement to impose additional tariffs on China is likely to only exacerbate the weakness.

We think the chairman’s hesitation about communicating the future rate path likely reflected the fact that the Federal Open Market Committee (FOMC) members are divided in their views. Two FOMC members dissented from yesterday’s decision to cut rates. And based on FOMC members’ rate projections in June, about half the committee thought no rate cuts would be needed this year, while others were forecasting 50 bps in cuts. The Fed’s final decision to cut by 25 bps was most likely a compromise, but we suspect that economic developments between now and September will ultimately garner a greater consensus to ease more.