The Federal Reserve cuts the benchmark rate by 50 basis points marking the first cut in over four years
A September rate cut was fully expected by markets, but whether it would be a 25 or 50 basis points (bps). Markets were putting almost coin-flip odds between all the way up to the announcement. Ultimately, it was 50bps, offering a strong signal that the Fed has shifted its focus from inflation to labor markets. Economic data has been softening, but not enough to signal a recession is imminent. However, we do believe that the risk of holding rates too high for too long is a bigger risk than inflation; the Fed seems to agree. Stocks shot up on the announcement but faded as the day went on; Thursday saw a strong rally.
The 50bps vs 25bps decision was not particularity important in isolation. The market is much more concerned about the future path of rates. In the Summary of Economic Projections SEP), policymakers indicated that there will probably be at least one more rate cut this year, but another 50bps cut is unlikely; the Fed usually moves in 25bps
The forecast for the longer term Fed Fund Rate in the SEP, which could be viewed as what policy makers see as neutral, has a wide dispersion ranging from 2.25% to 3.75%. As long as rates are above the neutral rate, rates are restrictive and should be slowing the economy and inflation. There is no way to know what the actual neutral rate is, but we believe somewhere around 2.5% is a good estimate. No member of the FOMC has the Fed Funds rate even sniffing 2.5% for almost two years. While we are not overly concerned about it right now, we do not think that the economy can handle two more years of restrictive policy without falling into recession. The good news is that in the short-run all members agree that even with the 50bps cut, policy is restrictive.
Bonds were mixed depending on where they fell on the curve. The front end of the curve came down as 50bps was not fully priced in, but the longer end of the curve saw rates increase. Long rates going up seems counterintuitive, but indicate that the cut was good for long term growth; we agree.
50bps offered a strong signal to the market that the Fed has turned its focus from inflation and to the labor market. This was the right move in our opinion and is supportive of risk assets. We’re cautiously sticking with the “don’t fight the Fed” mantra, but could grow concerned if policymakers cling to what we see as excessively high long-term rate expectations.