With the warm evenings of summer starting to take hold, the baseball season in full swing and the eyes of the media on the first of two expected debates between President Joe Biden and former President Donald Trump, Federal Reserve officials met in Washington to discuss their June rate decision.
A lot has changed since then, of course, with the evenings now cooler, the baseball playoffs looming and Vice President Kamala Harris tagging in for a retiring President Biden in the autumn election campaign.
The much bigger development in financial markets, however, was evident last night in Washington: The Fed, which only three months ago was trying to convince investors that it had penciled in just one rate cut for the rest of the year, delivered its biggest reduction since 2020 and forecast at least two more easing moves over the final months of the year.
By the end of next year, officials see a Federal Funds Rate in the region of 3.4%, implying a full percentage point of cuts in 2025 even as the central bank sees unemployment holding steady at 4.4%.
Related: Fed delivers on big rate cut, signals focus on cooling job market
"If the economy remains solid and inflation persists, we can dial back policy restraint more slowly. If the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we are prepared to respond," Fed Chairman Jerome Powell told reporters in Washington.
"Policy is well positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate," he added.
Curiously, the Fed's new rate forecasts came with only modest cuts to the growth outlook Fed officials had compiled, officially called the Summary of Economic Projections but better-known as the Dot Plots, and a slight trimming of the core-inflation outlook for this year and next.
Summer jobs data were certainly softer: Downward revisions for June and July tallies clipped around 89,000 jobs from the overall total. The August number suggested that while a slowdown in hiring could extend into the autumn, the broader labor market remains strong.
The Fed 'recalibration' trade
Inflation is definitely on the wane, but sticky services and housing costs are keeping core readings elevated and blunting progress toward the Fed's 2% target.
The economy, meanwhile, continues to defy recession forecasts. After growing 2.9% over the three months ended in June, it is holding that pace of expansion into the final weeks of the third quarter, according to the Atlanta Fed's GDPNow tracker.
So what changes have the Fed observed to trigger the "recalibration" of rate policy— a term Powell used no less than nine times during Wednesday's news conference in Washington — that forecasts at least another two quarter-point rate cuts following its outsized half-point move last night?
Related: The Fed Dot Plot is more important than a rate cut today
Bill Adams, chief economist for Comerica Bank in Dallas, says that fading job growth and slowing inflation (powered in part by falling gasoline prices) are the most likely drivers of the Fed's outlook change.
Powell, for his part, was more opaque.
"There’s nothing in the [Dot Plots] that suggests the committee is in a rush" to reach a neutral interest rate that balances 2% inflation and full employment, the Fed's congressionally directed mandate.
"The balance of risks are now even and this is the beginning of that process," he added. "We can go quicker if that is appropriate. We can go slower if that’s appropriate. We can pause if that’s appropriate."
Try telling that to the stock market, which is set to roar to a fresh record high Thursday, with the Dow testing the 42,000-point level. Investors are betting that easing Fed policy, rising corporate earnings and a gridlocked November election will deliver even more gains over the coming year.
Markets love interest-rate cuts
Peter Garnry, chief investment strategist at Saxo Bank, notes that equity markets have a history of outperformance as the Fed embarks on a rate-easing cycle, with median gains of around 28% in the two years that follow the first cut.
"There has been around 20 complete Fed-rate-cut cycles since 1957, and of those only three ended up with negative equity returns in the 24 months following their start," Garnry said.
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That doesn't mean there isn't some underlying uncertainty baked into the market's reaction.
Treasury bond yields jumped in the wake of the Fed decision, with rate-sensitive 2-year notes rising 4 basis points to 3.586% and 10-year notes last pegged at a one-week high 3.747%.
The moves likely reflect risks that the Fed's easing path could reignite inflation risks if the economy were to continue to expand, and the fact that Michelle Bowman lobbied for the smaller quarter-point rate cut, marking the first dissent from a Fed governor since 2005.
"To me the most interesting part was we finally had a Fed governor, on the record, dissent from the group," said Jay Woods, chief global strategist at Freedom Capital Markets.
"Usually we hear more about possible dissension in the minutes but they vote the same way," he said. "This was a tad more telling (that) maybe the descent to a soft landing will be a tad more bumpy than believed."
More Economic Analysis:
- Jobs report surprise adds to case for bigger Fed interest rate cuts
- Jobs report to signal timing and size of autumn Fed interest rate cuts
- Fed rate cuts may not guarantee a September stock market rally
The wider dispersion of outcomes in the September Dot Plots is also a concern, and suggests issues such as the election, as well as geopolitical risks in Europe, the Gulf region and Asia, could upend even the most sophisticated of projections.
"Although the Fed's direction is clear, the pace of future cuts will be heavily influenced by upcoming economic data," said Charu Chanana, head of FX strategy at Saxo Bank. "Persistent recession risks, combined with the looming U.S. elections, signal that heightened volatility could persist in the months ahead."
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