Fed Announces Interest Rate Cut, Investors Cheer
But is it too late?
The Federal Reserve will finally cut interest rates to restore strength to the U.S. economy, Fed Chair Jerome Powell announced on Friday.
Powell indicated that the central bank is taking its cues from the job market, not inflation.
“We do not seek or welcome further cooling in labor market conditions,” Powell stated in his address to the Fed’s annual gathering at Grand Teton National Park. “The time has come for policy to adjust.”
The Fed “all but ended the central bank’s inflation fight,” The Wall Street Journal reported on Friday. It remains unclear how fast and how far the central bank will bring interest rates down, the Journal reported in a separate article:
The Fed’s key rate is currently set in a range between 5.25% and 5.5%, widely viewed as a drag on economic activity. Market participants are divided as to whether the Fed will shave off 0.25 percentage point or 0.5 percentage point at the September meeting. Investors are also divided on what the Fed will do at its other two meetings this year, in November and December.
While Powell was forceful in laying out the Fed’s goals, he offered no specifics about the precise way officials will deliver them. He entirely avoided certain coded words like “gradual” and “methodical” that some colleagues in recent days had used to describe their expectation for a series of traditional quarter-point rate cuts. In doing so, Powell’s silence kept the door open to larger rate cuts if the labor market shows signs of greater weakness in the weeks ahead.
Powell and the Fed’s governors have been aiming for a “soft landing,” bringing down inflation without inducing a recession, as the Journal reports:
Central bankers raised interest rates aggressively in 2022 and 2023, determined to wrestle down the highest inflation in four decades. But the U.S. economy has defied expectations of a slowdown despite the elevated borrowing costs, and inflation came down while the labor market remained historically strong.
The recent rise in joblessness has thrown into question whether that situation will continue. The unemployment rate has risen from 3.4% in April 2023 to 4.3% in July. Inflation, using the Fed’s preferred gauge, was 2.5% in June, its most recent reading.
The stock markets rose on the news of the Fed’s intention to cut interest rates, even though investors have been awaiting that move for a long time and had priced it into the markets several times in recent months. “The tech-heavy Nasdaq Composite led Friday’s rally with a 1.5% gain, while the S&P 500 rose by 1.1%,” the Journal reported. “The Dow Jones Industrial Average veered upward by 1.1%, or 462 points, its second-highest close ever.”
Bond prices rose as well, the Journal reported:
Bonds rallied following his remarks in Jackson Hole, pushing down 10-year Treasury yields to 3.806% as traders pared back their rate expectations. Futures markets priced in a better-than-75% chance that the central bank will slash rates by at least one percentage point by year’s end.
In short, investors are happy that the Fed is finally committing to a reduction in interest rates. However, the Fed has waited far longer than it should have done, as is its habit, and the changes may arrive too late to avert an economic downturn.
As Cato Institute Senior Fellow Alan Reynolds notes, “The actual CPI inflation rate was not 2.92% this July (the 12-month average), but 1.88%. And the annual rate of inflation in the previous two months was zero—up less than seven-tenths of one percent in May, then down by the identical amount in June.” In addition, the use of the implied rental value of owner-occupied housing—which people of course do not actually pay—further drives up the official inflation number well beyond its practical effect.
The markets are hoping that the Fed’s upcoming rate reductions will avert a recession. It is possible that they will. It is also possible that they have arrived too late to do so.