What awaits us after that?

16.09.2024. / 15:39

WASHINGTON – When the Federal Reserve meets on Wednesday, officials are expected to mark the end of an era as they cut interest rates for the first time in four years and chart a path to lower rates over the next two years.

“This is an important meeting,” said former Kansas City Federal Reserve Branch President Esther George. “It is a meeting that has been hinted at since the end of last year. It’s been a long time coming.”

The central bank is expected to cut interest rates by a quarter of a percentage point to a new range of 5.0-5.25%, from its 23-year high of 5.25% to 5.5%, on Wednesday when their meeting on politics. The moves will officially mark the end of the most aggressive campaign to fight inflation since the 1980s.

Investors’ bets on how deeply the Federal Reserve will cut rates for the first time have fluctuated widely. As of early Monday, traders were forecasting a nearly 60% chance of a 50 basis point cut, compared to a 40% chance of a 25 basis point cut. On Friday, the odds were split 50-50, while a week ago they were 85% in favor of a smaller cut.

The rate cut will mark the first in a series of cuts as the central bank’s new era of easy money is expected to last through 2025 and 2026. This change will affect the American economy by making it cheaper for citizens to borrow money to buy houses, cars or credit cards.

Businesses will also have easier access to loans to finance their operations.

Federal Reserve officials will release new interest rate projections, known as a “dot plot,” of how many rate cuts they predict for the rest of this year and next.

Luke Tilley, veteran chief economist at Wilmington Trust, expects the Federal Reserve to cut rates by 25 basis points — and set a path for two more cuts this year, also by 25 basis points, before cutting rates at six of eight meetings next year. on Federal Reserve policy. He added that if the Federal Reserve can cut rates by 50 basis points at future meetings without upsetting markets, it will do so.

Tilley believes the Federal Reserve is lagging behind when it comes to cutting rates because “there wouldn’t be talk of 50 now if they just started cutting back in July and were on a slower path.” Still, Tilley says it doesn’t matter whether the Federal Reserve cuts rates by a total of 75 basis points or 100 basis points this year.

“What is more important is the trajectory, how they talk about it and how they present it, because their words carry more weight than their actions,” Tilley said, referring to market expectations about the Federal Reserve’s future moves.

As for former Kansas City Fed chief George, she expects a minimum rate cut of 25 basis points at each meeting through the end of the year. (There are three left, including Wednesday’s.)

She estimates the Federal Reserve will cut rates by 1.25 to 1.5 percentage points before pausing to assess how rates are doing in relation to the economy. But what she’s really interested in is “will this committee develop a narrative around the idea of ​​a 50 basis point rate cut.”

Meanwhile, Federal Reserve Governor Chris Waller said he is open to the size and pace of rate cuts based on the data — and if the data suggests the need for more cuts, he will support it. Waller said he was a big proponent of raising interest rates quickly when inflation accelerated in 2022, and would be a proponent of cutting rates quickly if appropriate.

The story behind the story

Officials are keen to cut rates, gaining confidence that inflation is likely to be heading towards its 2% target. The latest inflation data, as measured by the Consumer Price Index (CPI), shows that inflation continues to ease slowly, marking the fifth consecutive positive inflation report.

After fears that inflation had stagnated in the first quarter, officials said they needed more than one quarter of good inflation data to gain confidence that inflation was indeed falling. Inflation, based on the CPI, rose 3.2% in August and July, compared with 3.3% in June, 3.4% in May and 3.6% in April.

Inflation expectations are also falling. The difference between the yield on 10-year inflation-protected government bonds and standard bonds of the same maturity, a measure of expected inflation, is near its lowest point since early 2021. Inflation expectations for the next two years project CPI inflation at just 1.5%, below the Federal Reserve’s target of 2%.

Labor markets

At the same time, the labor market is cooling, as hiring slowed over the summer, with 118,000 new jobs in June, 89,000 in July and 142,000 in August — all below the average monthly gain of 202,000 over the previous 12 months.

This weakening has forced Federal Reserve officials to focus more on the labor market than on inflation.

Federal Reserve Chairman Jay Powell said in a speech in Jackson Hole, Wyoming, in late August that the Federal Reserve will “do everything they can to support a strong labor market as they move toward price stability.” He noted that the Federal Reserve does not “they neither want nor expect further cooling of conditions on the labor market” and that the current level of interest rates provides the Federal Reserve “enough space” to reduce rates in the event of a weakening labor market.

Federal Reserve watchers expect Powell to repeat many of these messages delivered at Jackson Hole.

Forecast

On Wednesday, Federal Reserve officials will also release forecasts for unemployment, inflation and the economic outlook. Powell will hold a press conference at 2:30 p.m. ET.

George said she sees several scenarios, including one where Powell could set the stage for larger cuts. “You could tell the story of a 50 basis point reduction,” said George. “He could come out at this meeting and say, ‘We’re going to be more aggressive in making sure we’re contributing to the labor market.'”

But Wilmer Stith, bond fund manager for Wilmington Trust, said: “I think Powell will be neutral.” Stith added that the Federal Reserve is very mindful of the pain that comes with higher unemployment, but is also aware of the cost of living for the average American.

EY’s chief economist, Gregory Daco, also agreed that “graduality” would prevail at the meeting, but said there could be mentions of larger rate cuts at future meetings.

Are recession fears still present?

There were concerns after the July jobs report that the economy had entered a recession, but the rebound in the August jobs report calmed those concerns.

Wilmington Trust’s Tilley expects the job market to continue to expand.

“We do not think that the labor market is entering a recession. However, that is the biggest concern,” he said.

Tilley still believes a soft landing is possible, but said: “The economy is slowing down and is vulnerable to a shock.”

And it wouldn’t necessarily take a major disruption. Tilley cited examples: a major oil shock that could hurt spending or a stock market crash that could cause businesses to cut back on hiring. He also said some of the policies of presidential candidates Donald Trump and Kamala Harris — like across-the-board tariffs or tax increases — could hit consumers next year.