Federal Reserve’s 50bps Rate Cut: No Panic, Just a Necessary Correction

Introduction: The Fed Cuts Rates After Fourteen Months of Pause

After weeks of speculation, the Federal Open Market Committee (FOMC) of the US Federal Reserve has initiated a new monetary easing cycle with a 50 basis points (bps) cut, bringing the federal funds rate range to 4.75%-5.00%. This marks the first rate cut since March 2020 and comes after a fourteen-month pause in policy changes. The move signals a shift in strategy, but unlike previous rate cuts, it doesn’t appear to be a response to an immediate crisis.

No Panic in the Boardroom

In contrast to aggressive rate cuts seen during major crises—such as the 50bps cuts in October 2008 after the Lehman collapse or March 2020 post-COVID-19 breakout—this recent cut is not driven by panic. Federal Reserve Chairman Jerome Powell remained calm and confident, reassuring the market that the economy remains on solid footing. He emphasized that the Fed is not in a rush to ease policy aggressively, dismissing concerns of an impending downturn.

“There’s nothing in the SEP (Summary of Economic Projections) that suggests the committee is in a rush to get this done,” said Powell, indicating that future decisions would be made carefully, with consideration at each FOMC meeting.

While the decision to cut the rate was significant, it wasn’t unanimous. In a rare dissent, one FOMC member, Michelle Bowman, voted for a more conservative 25bps cut. This further reinforced the notion that the cut was not a signal of panic but rather a measured move.

Committed to Price Stability Without Labor Market Pain

Chairman Powell proudly declared that the Federal Reserve has successfully managed inflation, stating, “The U.S. economy is in good shape. It is growing at a solid pace. Inflation is coming down.” According to recent data, US GDP expanded at a healthy 3% annual rate in the second quarter of 2024, with the unemployment rate at 4.2%—a level close to full employment. Inflation has also moderated to 2.2% as of August 2024.

Powell further emphasized the Fed’s goal of achieving price stability without causing a sharp increase in unemployment, a common consequence of disinflationary policies in the past. The 50bps rate cut, according to Powell, is a testament to the Fed’s strong commitment to maintaining this balance.

Neutral Rate Seen Close to 3%

Looking ahead, the FOMC anticipates further rate cuts, with expectations of a 25bps cut in both November and December, followed by a 100bps cut in 2025, and a final 25bps cut in 2026. This would bring the federal funds rate range to 2.75%-3.00% by the end of the cycle.

Powell also mentioned that the neutral rate—where monetary policy neither stimulates nor restricts the economy—could be significantly higher than in previous cycles. This suggests that the Fed is adapting to new economic realities and is prepared to adjust its approach accordingly.

Markets React Cautiously

Despite the rate cut, the U.S. markets didn’t react as one might expect. Equity, bond, and commodity markets all ended the day with marginal declines, while the U.S. dollar strengthened slightly. This reaction may be due to traders selling on the news or skepticism about the Fed’s optimistic economic outlook.

However, it’s important to note that this rate cut is more of a correction than an aberration. The Fed may have realized it was slightly behind the curve and is now catching up. Unlike previous crises, there’s no corporate balance sheet meltdown, no risk of global financial markets freezing, and no pandemic-driven shutdowns. This rate cut is a response to a normalizing economic cycle, and expecting extreme market reactions similar to 2008 or 2020 would be inappropriate.

Impact on US Markets and Beyond

In the coming weeks, US markets are expected to adjust to the new policy trajectory. Lower rates may stabilize the housing market and consumer spending, while bond yields could decrease, and the recent rush to gold as a hedge might unwind. The easing of borrowing costs may also normalize corporate discretionary spending, providing relief to sectors like IT services that have faced cost pressures.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.