The Federal Reserve lowered the target for the federal funds rate by 0.50%, or 50 basis points, to a range of 4.75% to 5.0% at its September meeting. The decision to reduce the policy rate was not unanimous. For the first time since 2005, there was one committee member that dissented. The accompanying statement, Summary of Economic Projections and comments from Fed Chair Jerome Powell indicated that more rate cuts are likely in the coming months. He referred to the move as a "recalibration" of policy to bring it in line with current conditions.
The Fed focuses on the job market
In the statement that accompanied the policy change, the Federal Open Market Committee (FOMC) indicated that the drop in inflation was giving them confidence that policy could be eased. However, in the press conference that followed the rate-change announcement, Powell emphasized that the slowdown in job growth was the key factor behind the decision to kick off the easing cycle with a larger-than-normal rate cut of 50 basis points, rather than 25 basis points. The Fed has a dual mandate—to keep inflation low and to support full employment. Since the last meeting, inflation has fallen faster than the Fed had anticipated, while the unemployment rate has risen more than expected.
With high inflation largely in the rearview mirror, the Fed's focus now is on its full-employment mandate. Powell indicated that the "balance of risks" has shifted—implying that supporting the job market has taken precedence over fighting inflation. In addition, the Fed's statement indicated that, "the committee is strongly committed to supporting maximum employment." Over the past few months, the pace of job growth has slowed substantially.
The Summary of Economic Projections (SEP) illustrated the reasoning behind the Fed's move. It showed modest changes for GDP growth in 2025 and beyond. Gross domestic product (GDP) is projected to grow at about a 2.0% pace. Inflation estimates were revised lower to 2.3% from 2.6% and to 2.1% for 2025.
The biggest change was to the unemployment rate forecast. For 2024, the projection for the unemployment rate was revised up to 4.4% from 4.0%, with upward revisions to 2025 and 2026.
Gauging the pace of rate cuts
The dot plot—which reflects where the various members of the Federal Reserve expect the federal funds rate to go during the next few years—shows more rate cuts are likely this year and during the next two years. It shows another 50 basis points (bps) in cuts are expected by the end of 2024 and another 100 bps by the end of 2025 and more in 2026. As usual, the range of estimates widens as they move into the future. There is less consensus about future rate cuts for 2025 and 2026. The Fed is still "data dependent," meaning that their forecasts are subject to change based on the economic information as it comes in.
In addition to the changes to the pace of rate cuts, the long-run rate estimate—often referred to as the "terminal rate"—nudged slightly higher to 2.9% from 2.8% at the previous meeting and is up from 2.5% from the year-ago figure. The gradual increase points to the growing belief that the economy is likely to grow at a stronger pace in the future than in the past.
In summary
The Fed's rate move was a strong signal that the rate-cutting cycle is underway with the goal to boost the job market. We continue look for yields to fall. Yields in the Treasury market had already discounted a decline in the federal funds rate, so market reaction was mild. However, for bond investors, reinvestment risk has already arrived, as Treasury bills with maturities of six or 12 months have already fallen below the current fed funds rate. We expect that trend to continue.
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