Fed Delivers Big Surprise; Cuts Rates by a Half Point
Looks like the Federal Reserve finally remembered where it put the rate cut button. After months of waiting, the central bank decided to give the economy a boost by trimming interest rates for the first time in four years.
The Fed on Wednesday cut the benchmark federal funds rate by 50 basis points (0.50%), bigger than the expected 0.25%. The central bank cited “greater confidence” on inflation.
Investors at first were jubilant and stocks soared, but then the equity averages lost ground in the final hour of trading. It was a classic case of buy on the rumor, sell on the news.
The main U.S. stock market indices closed mostly lower Wednesday as follows:
- DJIA: -0.25%
- S&P 500: -0.29%
- NASDAQ: -0.31%
- Russell 2000: +0.04%
The fed funds rate acts as a baseline for various lending rates, influencing everything from mortgages to auto loans. Historically, the Fed has adjusted rates in 0.25% increments and Wall Street had anticipated a cut of that modest size. However, recent data showing worsening economic conditions prompted the Fed to take a more aggressive approach.
Although the current unemployment rate of 4.2% remains low by historical standards, it has steadily risen over the past five months, a trend often seen before economic downturns. While layoffs remain relatively modest, hiring activity has slowed, leaving job seekers with fewer opportunities.
A study released this month by the Minneapolis Federal Reserve revealed that for every available job, there are now 1.5 applicants, well below pre-pandemic levels.
Meanwhile, the consumer price index (CPI) rose only 2.5% in July compared to the previous year, the lowest increase since February 2021.
At his customary post-meeting press conference Wednesday, Fed Chair Jerome Powell stated: “Our patient approach over the past year has paid dividends. Inflation is now much closer to our objective, and we have gained greater confidence that inflation is moving sustainably toward 2%.”
In a separate speech last month, Powell addressed the labor market’s challenges, stating, “We do not seek or welcome further deterioration in labor market conditions.” He warned that a weakening labor market could lead to a self-perpetuating cycle of job losses. Hence the Fed’s decisive move today.
As the Fed adopts a looser monetary stance, the benchmark 30-year U.S. Treasury yield has fallen below the important psychological threshold of 4.0% (see chart).
Some consumers have already started to benefit from the expectation of lower interest rates. Mortgage rates have dropped to their lowest point since February 2023, and auto loan rates are also on the decline. As rates fall, the housing market and retail sales should get a shot of adrenaline.
However, a single rate cut, even one as large as 0.50%, is unlikely to provide substantial relief to borrowers facing high financing costs. The greater impact will come from a series of rate reductions over time, which should more significantly ease financial pressure on businesses and households. Powell at his press conference intimated that more cuts will be forthcoming.
The political equation…
Donald Trump is almost certain to seize on the Fed’s rate cut as yet another conspiracy against him, unleashing his usual barrage of invective. A move to lower borrowing costs just weeks before the election will likely become fodder for his claims that the Fed is trying to influence the outcome. Trump has already suggested that such a cut would be an attempt to help Democrats secure victory.
Meanwhile, President Biden and Vice President Kamala Harris have mostly avoided commenting on the Fed’s actions, though some key liberal Democrats, notably U.S. Senator Elizabeth Warren (D-MA), have called for lower rates.
Of course, Powell and his fellow Fed officials maintain they ignore the political calendar when making decisions. Their independence from the White House allows them to focus solely on inflation and employment, even if their choices are politically charged.
Yet, that won’t stop politicians and the yabbering pundits on cable television from turning the Fed’s actions into a political talking point. Investors are wise to ignore the noise and focus on policy.
The Fed just provided a big injection of liquidity…and liquidity is the lifeblood of markets. The bull market is alive and well.
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John Persinos is the editorial director of Investing Daily. You can reach John via mailbag@investingdaily.com
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